The effects of financial liberalization on economic growth case study for ASEAN countries by using KAOPEN index

onomicGrowth CaseStudy forASEANCountriesByUsingofKAOPENInde... TABLE OFCONTENTS Page TABLE OFCONTENTS……… viii LISTOFTABLES.... 26 3.2.Measuring Financial liberalization.... 3.3.Endogenou

onomicGrowth CaseStudy forASEANCountriesByUsingofKAOPENInde

T h e N e t h e r l a n d s Programme( V N P ) T h e t h e s i s c o n s t i t u t e s onlymyo r i g

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ACKNOWLEGEMENT

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Lastbutnotleast,Iamverydeeplygratefultomyfamilythatisanindispensableelementtoconstitutemyachievement

Thisstudyaimstoverifytheassociationbetweenfinancialliberalizationandeconomic

g r o w t h i n A S E A N c o u n t r i e s , byu s i n g t h e a n n u a l p a n e l d a t a s e t from1 9

9 0 t o 2 0 1 3 a t t h e countryl e v e l T h e r e g r e s s i o n modeli s b a s e o n t h e f o r m o fgrowthmodelandsimilarlywithBekaertetal.(2005)model,inwhichtheChinn-

I t o i n d e x ( K A O P E N ) s e r v e s a s p r o x y f o r f i n a n c i a l l i b e r a l i z a t i o n ( K A O P E N ) i s fr eq uent ly u s e d inr e c e n t r e s e a r c h e s , s i n c e

i t i s u p d a t e d a n n u a l l y , availablei n Internet,and

Fixedeffectmodel(FEM)a n d r a n d o m e f f e c t m o d e l ( R E M ) t e c h n i q u e s

a r e u s e d t o e s t i m a t e t h e e f f e c t o f f i n a n c i a l liberalizationoneconomicgrowth.The resultoftheregressionprovidesth e evidencethatfinancialliberalizationhavepositiveeffectsoneconomicgrowthi n A S E A N c o u n t r i e s , i n c l

u d i n g V i e t N a m H o w e v e r , t h e s i g n i f i c a n t l e v e l i s n o t st ro ng in(REM)model,butstrongsignificantin(FEM).ThisresultisalsoillustratedbytherecentlyintegrationprocessofASEAN.TheexperimentofAS E A N s h o w s t h a t aso n e f o r

m o f financiall i b e r a l i z a t i o n , F D I h a v e n o t onlyb ro ug htforeigncapitalinflowsbutalsothecollateralbenefittothehostcountries

ASEAN,relationship,association,totalfactorofproduction(TFP),ForeignDirectInvestment(FDI)

TABLE OFCONTENTS

Page

TABLE OFCONTENTS……… viii

LISTOFTABLES x

LISTOFFIGURES xi

CHAPTER1:INTRODUCTION 1

1.1Problem statements 1

1.2Researchobjectives 4

1.3Researchquestions: 4

1.4Thescopeofstudy 5

1.5Researchstructure 5

CHAPTER2:LTERATUREREVIEW 6

2.1.Theoreticalliterature 6

2.1.1.EconomicGrowth and GrowthTheory: 6

2.1.2.FinancialDevelopment 8

2.1.2.1.FinancialDeepening 10

2.1.2.2.Financial Repression……… 10

2.1.2.3.Financial Liberalization……… 11

2.1.2.4.Financial LiberalizationandEconomicGrowth……… 13

2.2.EmpiricalStudies……… 18

2.3.ChapterRemarks……… 23

CHAPTER3:RESEARCHMETHODOLOGY 26

3.1.ModelSpecification 26

3.2.Measuring Financial liberalization 30

3.2.1.TheIMF’sAREAER 31

3.2.2.Quinn’sMeasure 32

3.2.3.KAOPENMeasure 34

3.2.4.KAMeasure……… 35

3.2.5.SHAREMeasure………

3.3.EndogenousProblemfromtherelationship betweenFinancial LiberalizationandEconomicGrowth………

………

35 36 3.3.1.InstrumentalVariables……… 37

3.4.MeasurementofVariables……… 38

3.4.1.Dependentvariable……… 39

3.4.2.IndependentVariables……… 39

3.4.2.1.KAOPENindicator(kaopen1)……… 39

3.4.2.2.Log InitialGDP(lgdp90)……… 40

3.4.2.3.Governmentconsumption/GDP(gconsume)……… 40

3.4.2.4.Secondaryschoolenrollment(second)……… 41

3.4.2.5.Population growth(pop)……… 41

3.4.2.6.Loglifeexpectancy(llife)……… 42

3.4.2.7.DummyVariables:(dlegal)………42

3.5.Datacollection……….4 4 3.6.ModelSpecification……….44

3.7.ChapterRemarks………4 5 CHAPTER4:RESEARCHRESULTS 46

4.1 OverviewEconomicGrowthandFinancial LiberalizationinASEAN………4 6 4.1.1 OverviewtheeconomicgrowthinASEANin theperiod1990–2013……….4 6 4.1.2 ForeignDirectInvestment(FDI)InflowsintoASEAN………4 8 4.1.3.ASEANBankingSector………5 1 4.1.4.Capital accountopennessinASEAN countries ……….5 3 4.2DescriptiveStatistics ……….5 6 4.3.ModelEstimationResult ……….6 4 4.3.1.ResultofTestforPanelDataModel.……….65

4.3.2.DiscussionontheResearchResult.………6 7 CHAPTER5:CONCLUSIONANDRECOMMENDATION 73

5.1.Conclusions 73

5.2Policyimplications 75

5.3 Researchlimitations 77

5.4 SuggestionsforFurtherResearch 77

……… REFERE NCES 79

APPENDIXA:PANELREGRESSIONMODEL 83

APPENDIXB:RESULTSOFHAUSMAN TEST 85

LISTOFTABLES

Table2.1:TheroleoffinancialLiberalizationineconomicgrowth… … … 24Table3.1:Theexpectedsignofvariablesinmodel… … … 43Table4.1:SummarystatisticsofVariablesusedintheregressions……… 56Table4.2:TheCorrelationonthesampleobservations… … … 64Table4.3:TheresultsofHausmanTest… … … 65

End

di n g toMckinnon(1973)andShaw(1973),assertedthattheimportantroleso ffinancialareessentialfortechnologicalinnovationandeconomic development.A

s strongevidencesinmostresearch,thereiswithoutdoubtinthissaying.However,thestudyoffinancialliberalizationgrowthnexushasreceivedoppositeo p i n

i o n s , whilethetendencytowardtheworldeconomicintegrationrequireslocalmarketo p e n n e s s i n c l u d i n g f i n a n c i a l m a r k e t , a n d s o m e a d j u s t m e n t s

i n f i n a n c i a l r u l e s , thusprovidingthegoingdebateaboutwhetherpositiveornegativeeffectoff i n a n c i a l liberalizationoneconomicgrowth

AccordingtoSachs andWarner( 1 9 9 5 ) , R od ri k( 20 00 ) technology andeconomic institutionshaverapidlydevelopedtoreachtheachievementofadvance,thed i s t a n c

e s b e t w e e n c o u n t r i e s b e c o m e n a r r o w e r Thisw i l l

e n c o u r a g e s moreinternationaltradea n d investmenttoreducecostsf o r bothconsumersandp r o d u c e r s , andthisstrongerrequirementtoex pe nd tradewillinturnenhancetheprocessofinternationaleconomicintegration.ThecommonexampleforinternationaleconomicintegrationistheWorldTradeOrganization(WTO),whic

hw a s e s t a b l i s h e d byagreemento f moret h a n 1 2 0 e c o n o m i e s Similarly,t h e I

n t e r n a t i o n a l M o n e t a r y F u n d ( I M F ) n o w i n v o l v e s n e a r l y u n i v e r s a

l m e m b e r s h i p , withmemberc o u n t r i e s promiset o c o m p l y w i t h t h e b a s i c p

r i n c i p l e s o f c u r r e n c y convertibility.Recently,g o i n g a l o n g w i t h t h e l a r g e

G D P a n d t h e h i g h v a l u e o f internationaltrade,China’scurrencywhichnamedChineserenminbi(RMB)havemetthecriteria forSpecialDrawingRight(SDR)basketasthedecidedofIMF’sE x e c u t i v e boardinNovember2015,andRMBwillbecometheconvertiblec u r r e n c y OnOctober1,2016RMBwouldjointheSDRbasket,togetherwiththefo ur o t h e r g l o b a l c u r r e n c i e s o f t r a d e I n t h e S

D R basketw i l l bei n c l u d i n g U S

dollar:4 1 7 3 p e r c e n t , E u r o : 3 0 9 3 p e r c e n t , C h i n e s e r e n m i n b i ; 1 0 9 2 p

e r c e n t , Japaneseyen:8.33percent,Poundsterling:8.09percentrespectively.Thefirsta d

v a n t a g e offreelyconvertibleRMBisthatitisveryinexpensivetobuyandsell,sothatcouldbereducethespreadcost(thedifferentpriceinbuyandsell)ofbank.Atsmallerscale,therearevaryinglevelsofeconomicintegration,includingp r e f e r e n t i a l

b e t w e e n memberc o u n t r i e s , t h e i n t e g r a t i o n b e t w e e n c o u n t r i e s i n thesamecontinent,regionsuchasintheEuropehaveestablishedtheOrganizationforEconomicCo-

operationandDevelopment(OECD),EuropeanUnion(EU),andthed e v e l o p m e n tofthisisEurozone.IntheAsiatherearetheinstitutionsthatcanbecounteda s T h e

A s i a

-P a c i f i c EconomicC o o p e r a t i o n ( A -P E C ) , t h e A s s o c i a t i o n o f S o u t h e a

s t AsianNations(ASEAN).Thenewone,ASEANEconomicCommunity( A E C ) hasestablished in theDecember2015, thatincluding Viet Nam andotherA S

E A N membercountries

(AEC)isthepledgedofmembercountriestorealizethep r i n c i p l e s o f a n E c o n o m i c C

o m m u n i t y w hic h b a s e s o n t h e i d e a o f t h e E u r o p e a n U n i o n ’ s model.ThefoundationofAECisbasedonthefourbasicelementswhicharenameda s : s i n g l e marketa n d p r o d u c t i o n b a s e , c o m p e t i t i v e economicr e g i o n , equitablee c o n o

h o t h e r majore c o n o m i c s i n t h e w o r l d a n d c o u l d b e l e a d t o moren e w b

u s i n e s s o p p o r t u n i t i e s Fromtheaboveelement,AECgivesthecoreprinciplesoft

heA S E A N singlemarketandproductionbasearefreeflowofgoods,services,i n v e s

t m e n t , capital,andskilledlabor.Asdemandinpromotingtrade,ASEANhas

obtainedi t s t a r g e t i n t h e t r a d e d u t i e s r e d u c t i o n B r u n e i D a r u s s a l

a m , I n d o n e s i a , Malaysia,Philippines,Singaporehavereducedtariffto0%,Cambodia,LaoPDR,Myanmara n d V i e t N a m a l s o r e d u c e t a r i f f t o 0-

5%.M o r e o v e r , t o e n c o u r a g i n g i n v e s t m e n t , t h e i n v e s t m e n t en v i r o n

m e n t h a s b u i l t i n a p r i n c i p l e t h a t en s u r i n g t h e liberalizationandprotectioninvestmentofcrossbordercountries.Inwhich,applyt h e b e s t p r a c t i c e s f o r treatmento f f

o r e i g n i n v e s t o r s a n d i n v e s t m e n t I n a d d i t i o n , i m p l e m e n t i n g thefreeflowofcapital,stockexchangesfrommemberareworking togethertofirststepestablishingtheASEANExchanges.ThisistheaimofpromotingASEANcapitalmarketsandcreatingmoreinvestmentopportunitiesin theregion

However,theprocess o f integration re qu ir es VietNam andmanyothercountriesopeningt h e l o c a l markets,i n c l u d i n g d o m e s t i c f i n a n c i a l m a r k e t s Nowadays,t h e governmentpolicesthatfocusoncontrollingmarketsarereceivedmanycriticized,f o r itislikelytobea

harmintheefficientfunctioninganddevelopmentoffinancialinstitutions.AsayingfromthewritingsofprofessorMcKinnon(1973)assertsthati m p e r f e c t capitalmarketsplayanimportantroleinhinderingthegrowthofd ev elo p i ng countries,sincethefragmentationoftheeconomiesinbothinstitutionsan d policymeasures.Thisshortcomingdiscouragestheeffectivemobilizationandr eallo cation ofresources.AsASEANincludingVietNampossessaregionthathasmorenatureresourcesandadvantageintherouteofglobalsupplychain,butupton o w t h e r e g i o n h a v e n o t d e v e l

o p e d a s e x p e c t e d , s o t h a t i t i s h a s a n i n c e n t i v e t o studyabouttheeffectoffinancialliberalizationandeconomicgrowthinASEANcountries.R e c e n t l y , f

i n a nc i a l l i b e r a l i za t i o n becomeso n e o f t h e m o s t concernsi n S c h o l a r s andpolicymakers.Inthemainstreamofliterature,thepositivecorrelationb e t w e e n financialliberalizationineconomicgrowthhasbeenpresentedinnumbero fstudiessuchasQuinn(1997),Klein&Olivei(1999),Quinn&Toyoda(2007),C h i n n &Ito(2005),Bekaertetal.(2005),Henry(2007),Koseetal

(2010),amongo t h e r s Ontheotherhand,theotherresearchhavenotsupportedforthehypothesis

Forthisreason,thisstudyisconductedtoanalyzetherelationshipbetweenfinancialliberalizationandeconomicgrowthinASEANcountries,basedonthemodelofB e k a e r t eta l ( 2 0 0 5 ) i n a n a l y z i n g m e t h o d o l o g y H o w e v e r , t h e r e a r e somed i f f e r e n

ng many

studiesoffinancialliberalizationfocusonalargecrosssectionco u n tr i e s andregion,itlikelytobeafewstudiesthatfocusonthisregion.Becausem a n y scholarsagreethatfinancialliberalizationcanputthepressurestoreformont h e localfinancialmarket,throughthistostrengtheningthefinancialsystem.I m p l e m e n t i n g thearticleof(AEC),VietNamwillhavesomechangesinfinancialp o l i c y m easu res T h i s l e a d s t o a

m o r e c o n c e r n a b o u t t h e b e n e f i t a n d u n e x p e c t e d e f f e c t s of

financialliberalization on theeconomic growth These arealsothereasonfort h i s s t u d y i s c o n d u c t e d , w h i c h i n t e n d s t o f i n d o u t w h e t

h e r f i n a n c i a l 2013.Theexpectationo f t h i s studyisf i n d i n g the positivee v i d e n c e bet wee n financial liberalizationandeconomicgrowth,foritpromotingtheintegrationprocess

1.3 ResearchQuestion

Thiss t u d y t e n d s t o f i n d o u t t h e impacto f f i n a n c i a l l i b e r a l i z a t i o n o neconomicg r o w t h , bya p p l y i n g t h e q u a n t i t a t i v e r e s e a r c h t o a p a n e l d a t a o f

g o Asdemandforopeningfinancialmarketistheoneofthefivecoreprincipleso ftheASEANsinglemarketandproductionbaseinmembercountries,thef i n a n c i a

l liberalizationprocessisexpectedtobeimplementedintheASEANcountries;in cl ud

in gVietNam.Th eA SE AN is chosenint he samplebecause the l a c k o f f i n a

n c i a l l i b e r a l i z a t i o n s t u d i e s f o c u s o n A S E A N c o u n t r i e s I n a d

d i t i o n , b e c au se VietNamisonememberofAEC,theneedisclarifyingthecorrelationoff i n a n c i a l l i b e r a l i z a t i o n a n d e c o n o m i c g r o w t h b e t w e e n c r o s s m

e m b e r c o u n t r i e s o f A E C

1.5 Thestructureofthestudy

Thispaperc o n t a i n s 5maincha pte rs Fo ll ow in g this f i r s t chapterofi n t r o d u

c t i o n, chapter2 p r e s e n t s thec r i t i c a l l i t e r a t u r e r e v i e w one c o n o

m i c growth,f i n a n c i a l development,f i n a n c i a l l i b e r a l i z a t i o n a n d t h e e f

f e c t s o f f i n a n c i a l l i b e r a l i z a t i o n o n economicgrowth.Next,regressionmodelandresearchmethodologyareexhibitedi n c h a p t e r 3,specifiesthe

offinancialliberalizationoneconomicgrowth.Chapter4givesabriefoverviewofeconomicg r o w t h a n d financialliberalizationinASEANcountries.Then,thedescriptivestatisticsofthesample,thea n a l y z i n g , d i s c u s s i n g a n d t h e r e s u l t o

f t h e s t u d y i s p r e s e n t e d i n thischapter.Finally,chapter 5concludesthemainfindings,limitationsa n d furtherresearches

Thischapterintroduces threemainparts.Thefirst sectionprovides definitionsoff i n an ci a l liberalizationandreviewstheoreticalbackgroundsabouttheroleoff in an c i a l l i b e r a l i z a t i o n i n e c o n o m i c g r o w t h T h e s e c o n d s e c t i o n s

u m m a r i z e s p reviou s e m p i r i c a l r e s e a r c h e s B a s e d o n r e l e v a n t c o n t e

n t s , t h e t h i r d s e c t i o n w i l l d ep i ct theconstructionofconceptualframeworkforthisstudy

o m i n a l terms,n o m i n a l G D P i s c o u n t e d includinginflation.Intermofrealterms,whichcalledrealGDP,iscorrectedfori n f l a t i o n T h i s meanst h a t t h e e f f

e c t s ofinflationa r e e l i m i n a t e d Tocomparet h e economicgrowthofonecountrytoanothercountry,GDPorGNPpercapitaisusedw h e n thepopulationdifferences betweencountriesareconsidered.Thegrowthofa n economycouldbeseenasanimprove

Thisisnotonlya s anincreaseinproductivecapacitybutalsoasanenhancementthequalityoflifeto thepeopleofthateconomy.Todepicttheissueofeconomicgrowth,basingontheneoclassical,theexogenousgrowththeory,endogenousgrowththeoryare

lativetol a b o r u n t i l t h e e c o n o m y o b t a i n s t h e s t e a d y s t a t e A t t h e s t e a d y

s t a t e , d e s p i t e a n

gychangeplaysthekeyrolefortheeconomytoovercomethatsteadystate.Endogenous grow th

theory

Baseonthefoundationsofneoclassical,endogenousgrowththeoryhasbeendevelopedt o e x p l a i n t h e l o n g r u n e c o n o m i c g r o w t h a s a r i s i n g frome c o

n o m i c activitiesthat are theprocessto create new technologicalknowledge.Asthisc o n c e p t drawstheoutlineoftheory,especiallythe“Schumpeterian”visionvarietyi n innovation.Endogenousgrowth theorydepictsthatendogenousgrowth islongru n growthataratedeterminedbyoneormorebyf a c t o r s generatedintheeconomicsysteminsteadofoutsidefactors, particularly thefactorsthatdominatet h e opportunitiesandincentivestocreate technologicalknowledge.Becauseofthis,it can draw themodelwith oneormore theseelementssuchasAKmodel,inwhicht h e engineforgrowthcanbesimpleaconstantreturntoscaleproductionfunction.Thisisth ef ir st versionof end og en ous g r o w t h t he or y establishedfromthep r o d u c t i o n function:

Y=AKα(HL)1-α

Aisstandingfortheproductiontechnology.WhenputH=K/

Lishumancapital,t h e r e isanewproductionfunctionY=AK.DividingtwosidesofequationbyL,itgivey=Ak.Thisprovesthatthemarginalproductivity

ofcapitalAdoesnotreducew h e n thecapitalstockincreases.Thismodelstillassumesconstantreturntoscale,b u t i t d o e s n o t e x p l i c i t t h e d i m i n i s h i n g r e t u r n t o

s c a l e T h e AKtheorya s s u m e s capitalas i mp or ta nt element t ha tdirectly contributesto t h e production T hi s alsoincreaseshumancapital,thenrisinglinearityoutputw i t h t h e capitalstock.AKt h e o r y pointsoutthataneconomy’slongrungrowratedependsonitssavingrate.T h i s meansthatahighersavingratewillconducttoahighergrowthrate,andhigherp o p u l a t i o n growthrateswillleadtolowerincomepercapita

AghionandHowitt(1998)thinkthattherearesomedifferentbetweenneoclassicalmodelandendogenousgrowththeory thatinendogenousgrowththeorythegrowthp e r c a p i t a l c a n c o n t i n u e w i t h o u t b a s i n g one x o g e n o u s t e c

h n o l o g y c h a n g e s , a n d t he r e isnoconvergenceofincome,sothatthepoorcountrieswillnotnecessarilyg r o w t h fasterthanrichcountries.However,likewithSolowmodel,thekeyroleofaccu mu lati on ofproductionfactorsandtheincreasinginproductivityinthegrowingprocessarealsoemphasizedinendogenousgrowththeory

Inthisstudybothoftheoriesareemployedtoexplainthecorrelationofthevariablesi n

r e g r e s s i o n model,t h e f a c t o r e f f e c t i n g g r o w t h i n t h e economy.F o r example,t he co n v e r g e n ce o f incomec o u l d b e i n t e r p r e t e d byneoclassical theory,a n d thetotalfactorproductivityincreasingisexplainedbyAKmodel,

2.1.2 FinancialDevelopment

Financialdevelopment

isdefinedasanimprovementinthequality,quantityandthee f f i c i e n c y o f f i n a n c i a l system.T h i s p r o c e s s i n v o l v e s t h e c o m b i n a t i o n o f m a n y activitiesandinstitutions

offinanceanddevelopment:thath i g h e r l e v e l o f f i n a n c i a l d e v e l o p m e n t s

p u r economicg r o w t h bya f f e c t i n g t o t a l f acto r p r o d u c t i v i t y g r o w t

h A c c o r d i n g t o L e v i n e ( 2 0 0 5 ) , f i n a n c i a l d e v e l o p m e n t h a p p e

n s whenfinancialinstruments,marketsandintermediariesareimprovedbetter,thentheyaffecttheinformation,enforcementandtransactioncosts

Intheliteraturefinancialdevelopmentspurgrowthbythewellfunctioningfinancials y s t e m thatcouldbebrieflypresentedthroughtwochannels:increaseinfinanciald e e

p e n i n g thatraiseinvestment,andefficientresourceallocationwhichenhancetheproductivitygrowthup

ratiooffinancialassetstoGDPth at meansi n c r e a s i n g p r o v i d i n g f i n a n c i a l s e r v i

c e s t o a l l l e v e l s o f a society.T h i s c o u l d encouragesaving,morecapitalaccumulating

,forthatinvestorscouldfindtheot hercapitalsourcestofinancefortheirprojects.Itmeansimprovinginvestment.

Inaddition,financial d e v e l o p m e n t playsanim po rt an t roleinraisingproductivity g r o w t h Assavingratesincreasing,saverscouldinvestinthefinancialsystemandg a i n p r o f i t s Whentheyd o s o , c a p i t a l r u n s i n t o t h e f i n a n c i a l markets,financiali n t e r m e d i a r i e s wherearewillinglytoscreening,selectingandmonitoringpotentialusersofcapital.Afterthat,thegoodprojectswillbefinancebytheoutsidecapitalan dt h e u n p r o d u c t i v e v e n t u r e s f a i l t o b e f i n a n c e d

Theactivityoffinancialsectorcouldbemeasurebytheroleofcommercial bankcomparedwithcentralbankortheimportanceofbankintheallocationofsociety’ssavings.“Commercial-

Centralbankassets”indicatorwhichformedbytheratioofa s s e t ofdepositmoneybanksdividedbythesumofassetsofdepositmoneybanksan d centralbankassets

The “ratioofcredittothe privatesector”is anotherindicatormeasuringtheactivityo ff i n a n c i a l s e c t o r a s w e l l a s t h e commonmeasureo f t h e e f f i c i e n c y o

f r e s o u r c e allocationi n t h e f i n a n c i a l s e c t o r T h i s i n d i c a t o r i s morea d

v a n t a g e o u s t h a n t h e measureso f m o n e t a r y a g g r e g a t e s b e c a u s e itc

l a r i f i e s t h e r e a l a m o u n t o f f u n d s f i n a n c e totheprivatesector.WhentheratioofdomesticcreditasapercentageofGDPi s h i g h e r , t h e e c o n o m y hash i

g h e r d o m e s t i c i n v e s t m e n t a n d h i g h e r l e v e l o f f inan ci al system development.D ome st ic credit top ri va te sectorcanbe use dasa p r o x y fortheprivatecredit(DeGregorio&Guidotti,1995).

Financialdeepening isdefined asthe increasingthe ratiooffinancialassetstoGDPth at meansincreasingprovidingfinancialservicestoalllevelsofasociety.Thisismeasuredbyformula:

𝑀

2 K=

𝐺 𝑃�𝑃WhereM2ismeasureo f t h e m o n e y supplyw h i c h i n c l u d i n g cash,c h e c k i n g , a n dsavingaccount

Itmayalsobecalculatedbytheratioasbelow

�𝑃

𝑟 𝑖𝑡�𝑃 �𝑃 K=

𝐺 𝑃�𝑃

Financiald e e p e n i n g g e n e r a l l y us ed top r e s e n t t h e meaningo f i n c r e a s i n g r a t

i o o f m o n ey supplytoGDP,thusexpressingtheliquidmoney.Inthetraditionmeaning,h i g h e r liquidmoneyleadstomoreinvestment,moreopportunitiesandthenhighereconomicgrowth.Asfinancialservicesareavailabletoindividualandhouseholds,t h e basicservicessuchashealth,educationbecomeeasilyt o beaccessedbycommonpeople,thusprovidinganimportantboosttopovertyreduction

AccordingtoKingandLevine(1993)financialdeepeningisoneoffourindicatorst omeasurefinancialdevelopmentofacountry.Intheirstudy,amongmanyotherstudies,financialdeepeninghasasignificantpositiveeffectoneconomicgrowth

2.1.2.2 FinancialRepression:

Thegovernmentpoliciesthatfocusedonrestrictingandcontrollingfinancialmarketshavebeenknowninliteratureasfinancialrepression.Manygovernments

feelthemselvestheneedtoimpose manytypeofrestrictions whichareclassifie

di n t o f o u r c a t e g o r i e s byt h e I M F ’ s A n n u a l R e p o r t o n E x c h a n g e A r r a n g e

m e n t a n d Excha ng e Restrictions(AREAER)

Sincet h e e a r l y 1 9 7 0 s , m a n y s c h o l a r s h a v e l o n g b e e n c o n c e r n e d t h a

t numerousgovernmentpolicieswhichfocusedoncontrollingfinancialmarket,foritwasfeltt h a t thesepoliciesaregenerallytakentobeabadthingnormativelythatimpededt h e e f f i c i e n t f u n c t i o n i n g , d e v e l o p m e n t o f f i n a n c i

a l i n s t i t u t i o n a n d d i s t o r t e d t h e domesticfinancialmarket.AccordingtoMckinnon(1973)andShaw(1973),botha u t h o r s showedtheirviewofpointasacritiqueofgovernmentrestrictpoliciesinf i n a n c i a l market.Manygovernments fee lthemselves th e needto intervene in thes p h e r e o f f i n a n c e t o mobilizea n d s u p p o r t f o r t h e a c t i v i t i e s t h a t theye x p e c t t o d e v e l o p d o m e s t i

c e c o n o m y T h e g o v e r n m e n t r e s t r i c t p o l i c i e s i n f i n a n c i a l marketm a y becomefromsomereasonssuchasthegovernment’sfearofdependenceonf o r e i g n

c a p i t a l i s m , t h e n e e d t o a i d s t a t e o w n firmso r p r e v e n t i n g domestics a v e r seekinghigherreturnininternationalmarket

QuinnandToyoda(2007)suggestthatthroughthe1980s manydevelopingc o

u n t r i e s c l e a r l y r e f u s e t h e m o d e l o f f i n a n c i a l o p e n n e s s p r o p o s e d byd

e v e l o p e d countriesbecausethefearofdependencyinterpretationofmoderncapitalism.Ifac o u n t r y were t o a c c e p t t h e e x p o r t o f f o r e i g n c a p i t a l , its e t s i t s

e l f u p f o r , a t b e s t , economicc o l o n i a l i s m Somec o u n t r i e s , h e n c e , f o r

b i d i n t e r n a t i o n a l c a p i t a l T h i s standpointshowst h a t d e v e l o p i n g c o u

n t r i e s s h o u l d b e t t e r k e e p i s o l a t e formr i c h c o u n t r i e s whoexploitpoorcountrieswascentraltodevelopedcountrywealthanddevelopi ng countrypoverty.Inthedevelopmentpointofview,developingnationss h o u l d u n d e r t a k e i

m p o r t s u b s t i t u t i o n i n d u s t r i a l i z a t i o n w h i c h a d v o c a t e s r e p l a c i n g f

o r e i g n importswithdomesticproductioninordertoimprovetheirtermsoftrade,

w h i c h requirespartialfinancialclosure

2.1.2.3 FinancialLiberalization:

Financialliberalizationisaverybroadtermthatusuallyhasthemeaningthatfewergovernmentr e g u l a t i o n s a n d r e s t r i c t i o n s i n t h e f i n a n c i a l m a r k e t Ino t h e r w

o r d s , liberalizationreferstoderegulationorremovingofcontrols.FollowingK u n t an d

L e v i n e ( 1 9 9 6 ) , d e r e g u l a t i o n o f i n t e r e s t r a t e a n d morel o o s e n e d e n t r

y p o l i c i e s ine x c h a n g e forgreaterprivateentities,oftenconductedtosignificantfinanciald ev elop men t Specially,inthedevelopingcountrieswheretherewasconsiderabler e p r e s s i o n o f g o v e r n m e n t p o l i c y i n t h e e c o n o m y m a n

a g e m e n t N e v e r t h e l e s s , t h e f e r v o r ofwhichfinancialliberalizationwasimplementedinsomecountriesinthel a c k o f o r l o w p e r f o r m i n g o f l e n d i n g

i n s t i t u t i o n s a n d i n s t r u m e n t , i m p r o v e morereforms.Overthepast

havereformedtheirdomesticf i n a n c i a l markets,d u e t o t h e r e q u i r e m e n t o f domesti

ca n d i n t e r n a t i o n a l d e v e l o p m e n t s Theshortdefineisthatfinancialliberalizationrefersmoretoliberalizationorfurther"openingup"oftheirowneconomiestoforeigncapitalandi n v e s t m e n t s , orthesimpleway:whenacountryallowsmoneytomoveinandoutofa countryfreely

s , s p e e d s u p p r o c e s s o f f i n a n c i a l d e v e l o p m e n t , h e n c e i m p r o v i n g t h eeconomicgrowth

al ReportonExchangeArrangementandExchangeRestrictions(AREAER)o f t h e I n t e r n a t i o n a l M o n e t a r y F un d ( I M F ) T h e r e a r e s o m e o f i n d i c a t o

r s t h a t a r e

yfrom(AREAER),“CAPITAL”by(Quinn,1997),“KAOPEN”by(Chinn&I t o , 2007),“KA”by(Schindler’s,2009)

Int h i s study,“ K A O P E N ” i n d i c a t o r i s c h o s e n t o p r o x y f o r financialo

p e n n e s s , b e c a u s e i t c o v e r s a p e r i o d timef r o m 1 9 7 0 t o 2 0 1 3 a n d i s a v

a i l a b l e i n i n t e r n e t WhileQuinn’sCAPITALdatastopattheyear2004,toooldtouse.Usuallyinther e g r e s s i o n estimation,Quinn’sCAPITALindicatorgivestheresultmoresignificantt h an KAOPENindicator.However,itisnotupdatedinrecentyears,sothatitisnotchosen.KAhasnodataforLaoPDRandCambodia,anditjustcoverfrom

p thevolumeoftradeandservice,andhencerampupthecompetitiveabilitiesoflocalcountry

Recentyears,agreatnumberofdescriptionsandanalyseshavebeenconductedtoc l

a r i f y therelationshipbetweenfinancialliberalizationandeconomicgrowth.Intheliterature,asthemainstreampointofviewisthatfinancialliberalizationhast h e p o s i t i v e r e l a t

i o n s h i p w i t h e c o n o m i c g r o w t h T h e f i r s t timem e n t i o n i n g o f liberalizationispresentedbyMcKinnon( 1 9 7 3 ) a n d S h a w ( 1 9 7 3 ) B o t h a u t h o r s

c r i t i c a l l y focusonfinancialrepression,foritwasknownas restrictingandcontrollinginfinancialmarkets.Thispresentedbytheinterventionofgovernmentsuchasenforcementtheinterestrateceilings,directedcreditandsubsidiestobanks.McKinnon(19

theeconomicsduetobothinstitutionsa n d policymeasuresleadtoreducetheeffectiveofmobilizationandreallocationof

modelhepointoutthatafirmfacesf in an cin g constraints ifus i n g onlyinternalf inance Because of t h i s , bo th au t h o r s adv ocat e forperfectcompetitionmarketFinancialliberalizationcouldfosteramorestrengtheninglocalfinancialmarket,sot h a

t leadsmoreefficientinallocationofresources,moreforeigninvestment,moresavingrate,providingopportunitiesforriskdiversification.AccordingtoBumaneta l (2013),theneoclassicalperspectivewhichassumesthatmarketsareefficientinallocatings c a r e r e s o u r c e , i s t h e s o u r c e o f m o s t o f c o n c e p t i n l i b e r a l i z a t i o n T

h i s perspectivehasbeenraisedtoadvocatethepositiverelationshipbetweenfinancialliberalizationofbothcredit(i.e.banking)a n d capitalmarketsl e a d toe c o n o m i c

g r o w t h I n t h e l i g h t o f t h i s c o n c e p t , a s i n t r o d u c i n g marketp r i n c i p l e s

a n d competitioninbankingmarketswillencouragegrowthininterestondeposits,andt h i s higherinterestconductstomoresavingsandthenmoreinvestment.Mckinnon( 1 9 7 3 ) , Bumanetal

n s u p t h e c a p i t a l a c c o u n t , capitalinflows contribute intoc a p i t a l stock.Financial liberalization providingopportunitytoriskdiversification,Bekaertetal

(2005)figuredoutthatimprovingriskdiversificationcouldreducethecostofequitycapitalandincreasei n v e s t m e n t B e c a u s e moref o r e i g n c a p i t a l s a r e a v a i l a

b l e a f t e r f i n a n c i a l liberalization,externalfinancemoree a s i l y approach,d i r e c t l

y decreasesfinancialconstraintsonfirms,so

itleadtomoreinvestments.Moreover,diversificationcouldh e l p toavoidthefulleffectsofdomesticshockasQuinn(1997)suggested

Financiall i b e r a l i z a t i o n a n d f i n a n c i a l d e v e l o p m e n t h a v e a c a u

s a l i t y c o r r e l a t i o n C h i n n andIto(2005)pointedthatfinancialliberalizationcanle

adtodevelopmentoff in an ci al systemsthroughthesechannelssuchas:lesseningfinancialrepressionto

protectf i n a n c i a l m a r k e t s t h a t e n s u r i n g r e a l i n t e r e s t r a t e t o r i s e i n i t s c o m p

e t i t i v e marketequilibrium Moreover, providingmoreportfoliodiversificationcouldr e d u c e c o s t o f e q u i t y c a p i t a l byr e d u c t i o n i n t h e e x p e c t e d r e t u

r n s t o c o m p e n s a t e r i sk s Inaddition,financialliberalizationstrengthensonfinancialinfrastructurebyp u t t i n g greaterpressureforreformingfinancialsystemandeliminatinginefficientf i n a n c i a l i n s t i t u t i o n s I n o t h e r s t u d i e s , K l e

i n a n d O l i v e i ( 1 9 9 9 ) g i v e t h e e v i d e n c e that financialliberalizationleadstofinancialdeepening

Financiall i b e r a l i z a t i o n c o u l d l e a d t o i n c r e a s e morei n t e r n a t i o n a l t r a d e

a n d moreintegrationinworldmarket.Removingrestrictionsoncapitalaccountandcurrent

a c c o u n t

c o n d u c t tomoreeasilyinpaymentthathelptomoretradetransaction.Thiswi ll enhancetoincreasethevolumeoftradeandservicesbetweenthe nationandforeign

o n f i g l i o l i ( 2 0 0 8 ) , H e n r y ( 2 0 0 7 ) , B e k a e r t e t a l ,

( 2 0 1 0 ) a m o n g o t h e r s H e n r y ( 2 0 0 7 ) , e m p h a s i z e t h a t f i n a n c i a l l

i b e r a l i z a t i o n c a n e n h a n c e t h e r i s e i n t o t a l f a c t o r p r o d u c t i v i t y ( T F

P ) T h e u p d a t e h y p o t h e s i s e m p h a s i z e s thatthere a re somethinggoalongwithfinancialliberalization, which could g i v e t h e b e n e f i t f o r t h e country,t h e p o t e n t i a l c o l l a t e r a l b e n e f i t I t c o u l d e n h a n c e t h e r a i s eoft o t a l f a c t o r p r o d u c t i v i t y bys t r e n g t h e n i n g i n s t i t u t i o n , k n o

wled g e s p i l l o v e r i n F D I M o r e o v e r , p r o v i d i n g o p p o r t u n i t i e s f o r r i s k diversification,t h a t c o u l d h e l p f i r m s a b l e t o i n v e s t i n h i g h e r g r o w t h t e c h

n o l o g y p r o j e c t s , thusprovidinganimportantboosttoTFP

Thepositivecorrelationbetweenfinancialliberalizationandeconomicgrowthhasb e e n presentedinnumberofstudiessuchas Quinn(1997),KleinandOlivei(1999),Qu in na n d T o y o d a ( 2 0 0 7 ) , C h i n n a n d I t o ( 2 0 0 5 ) , B e k a e r t e t

a l ( 2 0 0 5 ) , H e n r y (2007),K o s e e t a l

( 2 0 1 0 ) , e t c O n t h e o t h e r h a n d , theo t h e r r e s e a r c h h a v e n o t supportedforthehypothesisthatliberalizationspurgrowth,thatarethestudiesofRodrik(1998),Kraay(1998),Stiglitz(2000).Thestudiesthatsupporttofinancialliberalizationcanbestatedasbelow:Quinn( 1 9 9 7 ) p r o c e s s i n g a c r o s s c o u n t r y r e g r e s s i o nfromyear1 9 6 0 t o 1 9 8 9 , c o v e r i n g 6 4 c o u n t r i e s , p r o v e d t h a t f i n a n c i a l liberalizationisrobustlyandpositivelycorrelatedwitheconomicgrowth.Henotedt h a t f i

n a n c i a l l i b e r a l i z a t i o n s p u r g r o w t h s i n c e i t i n c r e a s e s t h e e f f i c i e n c y o f i

n v e s t m e n t s incapitalandlabor.Asashiftingofrelatingpriceinaneconomy,thei n

v e s t m e n t s couldchoosetoinvestinhighdemandand(or)lowsupplyininternationalmarkets.Becauseofthis,investmentsbecamemoreefficient.Bekaerte t al

(2005)usingtheequitymarketopennessindicatorproxyforfinancialliberalizationwhichcovering95countries,demonstratedthattheresultoftheanalysisp r o v e t h e p o s i

t i v e e f f e c t off i n a n c i a l l i b e r a l i z a t i o n one c o n o m i c g r o w t h T h e resultalsodisplaythatequitymarketliberalizationinducerealpercapitaGDPincreaseanapproximate1%annual.T h i s resultwasstatisticallysignificantandr o b u s t t o d i f f e r e n t g r

o u p o f c o u n t r i e s , r e g i o n a l i n d i c a t o r v a r i a b l e C h i n n a n d I t o (200 5)a

n a l y z i n g t h e d a t a o v e r t h e 1 9 7 0

-2 0 0 0 p e r i o d , c o v e r i n g 1 0 8 c o u n t r i e s , pointedo u t t h a t f i n a n c i a l l i b

e r a l i z a t i o n c o n t r i b u t e t o e q u i t y m a r k e t development,a n d tradeopennessispreconditionforfinancialliberalization,andthencetofi nan ci al development.Bumannetal.(2013)conductedameta-

analysisoffinancialliberalizationandeconomicgrowthnexus.Thisanalysisusealargersamplethano t h e r previousstudies,foritbasedonasampleof60otherempiricalstudies.Thismethodologyislikelytoprovideasynthesisoftheeffectoffinancialliberalizationo n economicgrowth.Theresultofthisanalysisprovedthatfinancialliberalizationh a s a p o s i t i v e , i m p a c t o n e c o n o m i c g r o w t h , b u t n o t r o b u s t T h

i s s u g g e s t e d t h a t f i n a n ci al l i b e r a l i z a t i o n i s n o t a s i n g l e r o a d tor e a c h stronge c o n o m i c g r o w t h T o

Stiglitz(2000)arguedthatitislikelytobeafallacywhenconsideringthefinancialmarketasthesameordinarygoodsandservicesmarket.Asfundamentaltheoryoff i n a n c i

a l liberalizationbasedonconventionalneoclassicalmodel,thisperspective

e x p l a i n s theoperationsoffinancialandcapitalmarketarethesamewaysofo r d i n a r y goodsandservicesmarketwork,foritdoesnotenoughconcernaboutthespecialwaysoffinancialandcapitalmarketsd i f f e r f r o m ordinarymarkets.T h e mainfunctionof capitalandfinancingmarkets iscollectingandprocessingi n f o r m a t i o n , especiallyinratingthefirmsandprojectswhicharemostlikelytogainh i g h e s t returns,andafterthat,monitoringthelendingfundstoensurethattheusingt h e m a r e i n s u i t a b l e

a p p r o a c h R e l y i n g o n thisi d e a , Stiglitz( 2 0 0 0 ) a n d o t h e r thoughttha

tt h e financialliberalizationdoesnotresolvethep r o b l e m o f f i n a n c i a l marketssuchastheasymmetricinformation T hi s problemcanma ke a barrierto i m p e d e thefinancialintermediationfromobtainingthemoreefficientintheliberalizedmarkets.Infact,whent h e bankersf i n d somebadsignalsf o r m aneconomic,theydrawtheirmoneyoutofthecountry.This isalso truein thecasefort h e mostinvestorsandlenders,wholookattheeconomicsignalsandthinkthatallotherinvestorsarelookingatthesamesignalstomadeadecisionwhenorwhethertodrawtheir

moneyout.Moreover,capitalmarketliberalizationshowstotheworldhowthecountry’svicissitudesrelatedtothechangesineconomicconditionsoutside the

opinionsconcerningab o u t “emergingmarketrisk”,aconsiderablecapitaloutflowsoutofthecountry.A s capitaloutflow iseasier than capitalinflow,financialliberalizationlead tosome

1999)usetheindicator“Share”proxyforc a p i t a l accountliberalization,regressedthe

changeinfinancialdepth,intheperiodo f1986to1995,coveringcrosssectionof82countries,thatincludingdeveloped a n d developingcountries.Theresultofthestudyisthatthereisaclearlyimpactofc a p i t a l accountopennessonthechangingoff in anc ia l depth.T h e n theyalsousedt h e changeinthefinancialdepthasdependentvariabletoestimateagrowthmodelandtheresultshowsthatfinancialdevelopmentissignificanteffectongrowthpercapita.Theauthorsfindapositiveeffectofcapitalaccountliberalizationoneconomicgrowthindevelopedcountries,buttheresultisdifferentinnonindustrialcountries,f o r t h e r e i s n o e v i d e n c e t h a t c a p i t a l

a c c o u n t l i b e r a l i z a t i o n s u p p o r t t o economicgrowthinnonindustrialcountries.Similarly,Bailliu(2000)alsoobtainstheresultthatcapitalaccountopennessinduceseconomicgrowthbyinstigating

thedevelopmentinfinancial.Inthisstudiest h e authorjustfocusondevelopingcountries,forthepaneldataiscover40d ev elop in g countriesinthetimeperiodfrom1975–

95;heinvestigatenotonlytheFDIbutalsoabroadofcapitalflowsoneconomicgrowth,andhighlighttheroleofdomesticfinancialsectorsinthelinkagebetweencapitalflowsandeconomicg r o w t h T h e r e s u l t o f h i s studys u g g e s t e d t h a t d o m e s t i c f i n a n c i

a l s e c t o r playanimportantrolet o makes u r e t h a t i n t e r n a t i o n a l c a p i t a l f l o w s

e n c o u r a g e e c o n o m i c

growthindevelopingcountries.Heconcludedthatcapitalopennessspureconomicg r

ow th i n t h e c o u n t r i e s t h a t h a v e o b t a i n e d

a c e r t a i n l e v e l d e v e l o p m e n t i n t h e banking system.Otherwise,theeffectofcapitalflowsoneconomic

growthisfoundt o b e n e g a t i v e T h e e x p l a n a t i o n ist h a t c a p i t a l i n f l o w i n g i n

t o c o u n t r i e s w i t h l o w l e v e l developedbankingsectorslikelytobechanneledfromproductiveinvestmentintospeculationtransactions

Edwards(2001)presentedtheresultofhisstudy,agreeingwiththeideasthatthee f f e ct offinancialliberalizationoneconomicgrowthdependonthelevelofdevelopmento f a n e c o n o m y H e c o n c l u d e t h a t c a p i t a l a c c o u n t o p e n n

e s s h a s a negat iv e e f f e c t o n e c o n o m i c g r o w t h i n t h e c o u n t r i e s w

h e r e a r e l o w e r l e v e l o f income,buthasapositiveeffectinindustrialcountriesandinthericheremergingmarketcountries.EdwardusedbothQuinnvariablesandshareproxyforfinancialliberalizationintheestimateregression,inthesampleof60countries,coveringthep e r i o d of1980syears.TheresultshowsthatQuinnvariablesaresignificantassociated withgrowinpercapitalincome.However,theSharevariablegivestheresultthatisnotrobustinhisregression

Bonfiglioli(2008)appliedanewmethodtoevaluatetheimpactoffinancialliberalizationoneconomicperformance.Becausehethoughtthatitisv e r y importanttok n o w i n gaboutmechanismschannel,throughwhichfinancialliberalizationaffectseconomicgrowth,toassessthecostandthebenefitsoff i n a n c i a l openness.Heattemptedtoevaluatetheimpactoffinancialliberalizationo n economicp e r f o r m a n c e t h r o u g h a

s s e s s i n g e f f e c t off i n a n c i a l l i b e r a l i z a t i o n ont o t a l factorof productivity.Heexploitedthedataof70countries,coveringfromthep eri o d o f 2 5 yearsf r o m 1 9 7 5

t o 1 9 9 9 T h e r e s u l t i s o v e r a l l p o s i t i v e e f f e c t offi n a n ci a l liberalizationontotalfactorsproductivitygrowth,andnegligibleini n v e s t m e n t

Bonfigliolithoughtthatfinancialopennessasintegrationinthemarketoffinancialservicesthatcangeneratethegainsfromtradeasthesamethegainsfromtradeino r d i n a r y goods.Inthecountrieswithimperfectfinancialmarket,financialservices

suchasscreening,monitoring,debtstructuringcanplayaroleasimportantfactorofproductionforfirmthatneedtofindmoreexternalcapital.Likeasordinarygoods,t h e differencesinquality,diversifiedandspecializingofaproductgeneratesdemandfortrade.Becausetherearesomedifferencesinthequalityand

varietiesoff i n a n c i a l acrosscountriesandsectors,financial

liberalizationcanleadtogettypicalg a i n s fromtrade.Ontheotherhand,

thespecialization

offinancialservicehelpsforallfirmsintheworldtobuyanygivenfinancialserviceatthebestprice.F u r t h e r m o r e , firmsmayfindoutthemostappropriate financialinstruments whena c c e s s i n g tonewvarietiesoffinancialservices.Inthelightofthesestatements,theg r o w t h i n T F P c o u l d b e e x p l a i n e d byt h e i n c r e a s i n g i

n a l l o c a t e d e f f i c i e n c y , assuggestionof Galindoetal.(2007)inhisempiricalstudy.Onemoreexplanationfort h e growthofTFPisthatfinancialliberalizationprovidesthetoolsforinternationalr i sk diversification.Astheimprovementinrisksharing,theriskierandmoreprod uctive p r o j e c t s w i l l b e e a s i l y financed,

d e p e n d e n t

variableforfivenon-overlappingfiveyearsperiod.Intheregressionoff i v e yeargrowthrates,“share”var

iableisusedtoproxyforcapitalaccountliberalization.Thereareotherscomparablev

ariablessuchascurrentaccountcontrols,andasystemofmultiformexchangerates,thatareexploitedfromIMF’s