Does financial integration spur economic growth in china the way to be an economic powerhouse

BỘ GIÁO DỤC VÀ ĐÀO TẠO TRƯỜNG ĐẠI HỌC MỞ THÀNH PHỐ HỒ CHÍ MINH BÁO CÁO TỔNG KẾT ĐỀ TÀI KHOA HỌC VÀ CÔNG NGHỆ CẤP CƠ SỞ Does Financial Integration Spur Economic Growth in China?. BỘ GI

BỘ GIÁO DỤC VÀ ĐÀO TẠO

TRƯỜNG ĐẠI HỌC MỞ THÀNH PHỐ HỒ CHÍ MINH

BÁO CÁO TỔNG KẾT

ĐỀ TÀI KHOA HỌC VÀ CÔNG NGHỆ CẤP CƠ SỞ

Does Financial Integration Spur Economic Growth in China?

The Way to be an Economic Powerhouse

Mã số: E.2019.24.3

Chủ nhiệm đề tài:

ThS HỒ MINH CHÍ

TP HCM, 02/2021

BỘ GIÁO DỤC VÀ ĐÀO TẠO

TRƯỜNG ĐẠI HỌC MỞ THÀNH PHỐ HỒ CHÍ MINH

BÁO CÁO TỔNG KẾT

ĐỀ TÀI KHOA HỌC VÀ CÔNG NGHỆ CẤP CƠ SỞ

Does Financial Integration Spur Economic Growth in China?

The Way to be an Economic Powerhouse

Mã số: E.2019.24.3

Xác nhận của tổ chức chủ trì Chủ nhiệm đề tài

Hồ Minh Chí

TP HCM, 02/2021

DANH SÁCH NHỮNG THÀNH VIÊN THAM GIA NGHIÊN CỨU ĐỀ TÀI VÀ ĐƠN VỊ PHỐI HỢP CHÍNH

BỘ GIÁO DỤC VÀ ĐÀO TẠO

TRƯỜNG ĐẠI HỌC MỞ THÀNH PHỐ HỒ CHÍ MINH

THÔNG TIN KẾT QUẢ NGHIÊN CỨU

1 Thông tin chung:

- Tên đề tài:

Does Financial Integration Spur Economic Growth in China?

The Way to be an Economic Powerhouse

- Chủ nhiệm: ThS Hồ Minh Chí

- Cơ quan chủ trì: Trường Đại học Mở Thành phố Hồ Chí Minh

- Thời gian thực hiện: 10/2019 – 4/2021

2 Mục tiêu:

Mục tiêu tổng quát của đề tài: Đánh giá lại mối quan hệ giữa tăng trưởng và tài chính thông qua phân tich chuỗi thời gian Trên cơ sở đó, đề tài đề kỳ vọng đề xuất một số gọi ý chính sách có ý nghĩa cho quá trình phát triển tiếp theo của nước nhà

3 Tính mới và sáng tạo:

Trung Quốc trở thành cường quốc kinh tế đứng thứ hai trên thế giới trở thành một chủ đề nghiên cứu hấp dẫn trong vài thập kỷ trở lại đây Các chỉ số thống kê chỉ ra một sự bứt phá vượt trội của nền kinh tế Trung quốc từ những năm 1980 Đầu tiên, cuộc cải cách kinh tế năm 1979 của Trung Quốc là nền tảng cho sự tăng

trưởng mạnh mẽ của đất nước này từ năm 2000 cho đến nay Vốn nội địa của Trung Quốc tăng từ 417 tỷ đô la năm 200 lên đến 5.000 tỷ đô la và năm 2015 Bên cạnh đó, vố đầu tư trực tiếp nước ngoài (FDI) và Trung Quốc cũng gia tăng từ 68

tỷ đô năm 2004 lên đến 171.5 tỷ đô vào năm 2008 Đặc biệt, năm 2016 đánh dấu lần đầu tiên Trung Quốc đạt thặng dư trong đầu tư nước ngoài Đấy là xu hướng cho thấy quốc gia này đang có khuynh hướng mở rộng phát triển đầu tư ra các nước ngoài

Các nghiên cứu về tài chính và tăng trưởng trước đây đã chỉ ra một số tác động của tài chính phát triển đến tăng trưởng kinh tế và ngược lại Hầu hết các nghiên cứu tập trung vào dữ liệu vĩ mô (Anwar & Cooray, 2012; Edison, Levine, Ricci, & Sløk, 2002; Gourinchas & Jeanne, 2006; Imbs, 2006; Kose, Prasad, & Terrones, 2003; Lane & Milesi-Ferretti, 2003; và Menyah, 2014) Một số nghiên cứu khác sử dụng dữ liệu thời gian của thị trường tài chính để phân tích mối quan

hệ giữa tài chính và tăng trưởng cho một quốc gia (Cheung, Chinn, & Fujii, 2005; Girardin & Liu, 2007; Guiso, Jappelli, Padula, & Pagano, 2004; và Peia & Roszbach, 2015) Có rất ít nghiên cứu sử dụng dữ liệu chuỗi thời gian ở cấp độ quốc gia trong chủ đề nghiên cứu này (Ang, 2008b & 2010; và Anwar & Sun, 2011) Đây là một trong các điểm mới của nghiên cứu này, đặc biệt là mối quan hệ tài chính – tăng trưởng ở cấp độ quốc gia tại Trung Quốc chưa được xem xét một cách riêng biệt Nghiên cứu này mong muốn đóng góp vào cơ sở lý luận của mối quan hệ tăng trưởng – tài chính, dưới góc độ phân tích chuỗi thời gian, sử dụng dữ liệu cấp độ quốc gia Trong đó, phương pháp tự hồi quy hạng trễ (ARDL) được ứng dụng trong nghiên cứu này để giải quyết vấn để ước lượng chuỗi thời gian với

cỡ mẫu nhỏ và xác định sự tồn tại của mối quan hệ đồng tích hợp giữa tăng trưởng

và hội nhập tài chính Cuối cùng, nghiên cứu của chúng tôi sử dụng bộ số liệu mới nhất về hội nhập tài chính, bao gồm hai định nghĩa “de facto” và “de jure”, được phát triển bởi Dreher (2006), Dreher và cộng sự (2008), và cập cập nhận gần đây nhất bởi Gygli và cộng sự (2019)

4 Kết quả nghiên cứu:

Nghiên cứu này được thực hiện nhằm xem xét mối liên hệ giữa tăng trưởng kinh tế và hội nhập tài chính tại quốc gia đông dân nhất thế giới – Trung Quốc Áp

dụng phương pháp phân tích chuỗi thời gian ARDL (the Auto-Regressive Distributed Lags) và ứng dụng bộ số liệu mới nhất về toàn cầu hóa, chúng tôi tìm được một số kết quả sau:

- Chính phủ Trung Quốc đã đạt được thành công nhất định trong quá trình chuẩn bị cho công cuộc hội nhập kinh tế toàn cầu, đặc biệt là lĩnh vực tài chính

- Nghiên cứu xác nhận có mối quan hệ dài hạn giữa hội nhập tài chính

“thực” và tăng trưởng kinh tế tại Trung Quốc

- Mối quan hệ nhân quả hai chiều giữa hội nhập tài chính vào tăng trưởng kinh tế tại Trung Quốc được khẳng định thông qua kiểm định Granger

ThS Hồ Minh Chí

MINISTRY OF EDUCATION AND TRAINING

HO CHI MINH CITY OPEN UNIVERSITY

INFORMATION ON RESEARCH RESULTS

1 General Information:

 Project title:

Does Financial Integration Spur Economic Growth in China?

The Way to be an Economic Powerhouse

 Code number: E.2019.24.3

 Coordinator: Mr Ho Minh Chi

 Implemeting institution: Ho Chi Minh City Open Univeristy

3 Creativeness and innovativeness:

How did China become the world second largest economy in recent years? Starting from the emerging since middle 2000s, China seemed to safely rise up regardless many global crisis, especially the global financial crisis in 2007-2008 and the world repression in 2010-2012 Since these incredible developments, China has been an attracted investigation for a lot of researchers Chinese market

two largest global crisis above At first, broad money in China increased from

1979, when Chinese government started to reform the economy Secondly, the domestic capital formation suddenly increased from 2000 (approximately 417 billion USD), and vertically rose up from 2006 to 2015 (around 1.1 thousand billion to around 5 thousand billion USD) Thirdly, FDI flows in China are also notable FDI inflow to China went up from early 1990s with a maintained volume

It started huge movements from 2004 (around 68 billion USD in 2004 to 171.5 billion USD in 2008) Meanwhile, FDI outflow from China hidden its play until

2013 Especially, in 2016 China had a surplus from FDI flows in which FDI outflow excessed the inflow by around 41.6 billion USD

There is an endless argument on finance & growth nexus Various researches capture different effect of finance on growth There are positive, negative, and irrelevant relations between financial development and economic development reported by numerous empirical works Generally, researches conducted on aggregate level usually investigate in panel data while time-series analysis is mostly employed in micro researches As panel data at aggregate level, previous studies targeted to identify a typical influence of finance on growth or vice versa This kind of research cannot isolate a special case like China in order to shield the light to a particular puzzle

The motivation for this study is the rapid development of China in two recent decades We try to shield the light on finance-growth nexus in China, especially the growth effect of financial integration This research try to contribute empirical evidence for the finance & growth nexus under time-series point of view for a single nation at aggregate level, by employing the recent updated data on which is firstly developed by Dreher (2006)

- The cointegration between financial integration and economic growth exists in China

- We find bidirectional causality between financial integration and economic growth in China

5 Products:

A paper has been published on Economies This journal is indexed in Web

of Science’s ESCI (the merging Sources Citation Index) with the CiteScore of 1.6

as at November 2020 The journal is also indexed in Elsevier’s SCOPUS (Quarter 2)

6 Transfer alternatives, application institutions, impacts and benefits of research results:

The findings from the project are a useful informative reference source of information for undergraduate and graduate students, especially in the major of Economics and Agriculre at Ho Chi Minh City Open University Others students who are interested in the field of agricultural economics will benefit from the project too

Ho Chi Minh City, 21 February 2021

Implemeting Institution

(signed, named and sealed)

Coordinator

Mr Ho Minh Chi

TABLE OF CONTENTS

1 INTRODUCTION 11

2 LITERATURE REVIEW 13

2.1 RELATIONSHIP BETWEEN FINANCIAL DEVELOPMENT AND ECONOMIC GROWTH 13

2.2 THE ROLE OF INTEGRATION AND LIBERALIZATION IN FINANCIAL SYSTEM 16

3 METHODOLOGY AND DATA 19

3.1 METHODOLOGY 19

3.2 TIME-SERIES ANALYSIS STRATEGY 19

3.3 VARIABLES AND DATA SOURCES 22

4 RESULTS 25

4.1 DESCRIPTIVE STATISTICS 25

4.2 CO-INTEGRATION ANALYSIS 31

5 DISCUSSION 39

6 CONCLUDING REMARKS 41

REFERENCES 43

LIST OF TABLES

Table 1 Description of variables used in the current research 24

Table 2 Statistical description 26

Table 3 Paired correlation among variables in the model 31

Table 4 Unit root test results proposed by Dicky-Fuller and Zivot-Andrews tests 32

Table 5 Gregory-Hansen cointegration test 33

Table 6 Cointegration test by ARDL bound test 33

Table 7 Long run and short run effects reported by ARDL regression 36

Table 8 Robustness tests 37

LIST OF FIGURES

Figure 1. Foreign Direct Investment in China from 1982 to 2017 (measuring

by million USD) 27

Figure 2 FDI flows and Exchange reserve in China from 1970 to 2017

(measuring by million US dollar) 28

Figure 3 Capital formation and FDI flows in China from 1970 to 2017

(measuring by million US dollar) 29

Figure 4 Economic growth (GDP) and Capital formation in China from 1970

to 2017 (measuring by million US dollar) 30

Figure 5 Causal relationship for model 3 (direction of the arrow describes

direction of causality) 38

Figure 6. Causal relationship for model 4 (direction of the arrow describes

direction of causality) 38

1 Introduction

China been the world second largest economy is a surprise for not only practitioners but also researchers on around the globe Since middle 2000s, the country has seemed to safely rise up regardless many global crisis, especially the global financial crisis in 2007-2008 and the world repression in 2010-2012 Throughout these incredible developments, China has been an attracted investigation for a numerous researches (Girardin & Zhenya, 2007; Okazaki & Fukumoto, 2011; Xu

& Gui, 2019; Wang & Schuh, 2000; and Yin, 2009) Chinese market underlined many interested information if we search on its macro data during the two largest global crisis above At first, broad money in China increased from 1979, when Chinese government started to reform the economy Secondly, its domestic capital formation sharply increased from 2000 (from 417 billion USD), and vertically rose up from 2006

to 2015 (around 1.1 thousand billion to around 5 thousand billion USD) Thirdly, FDI flows in China are also notable FDI inflow to China went up from early 1990s with a maintained volume It started huge movements from 2004 (around 68 billion USD in

2004 to 171.5 billion USD in 2008) Meanwhile, FDI outflow from China hidden its play until 2013 Especially, in 2016 China reached a surplus in FDI in which the outflow excessed the inflow by around 41.6 billion USD Along with the improvement

of FDI pattern, the nantional exchange reserve also caught up with the internationalization The movement of Chinese reserve was quite similar with FDI inflow in the early of 2000s For example, in early 2000s, exchange reserve of China began increasing with a flat slope Then it stared to fly up from 2004 as same as the shape of FDI inflow to China but with a far higher magnitude Last but not least, Chinese GDP continuously rose up as a vertical slope from middle 2000s to 2015, regardless the two largest global crisis in 2008 and 2012 These evidences raises a question for scholars, practitioners, and policymakers about how incredibly China so success in two decades ago, given a lot of instability of the world economy, especially the sovereign debt issue in European community These evidence implied that (i) the domestic financial system in China has been highly responsed with the global

financial system, (ii) Chinese government did a well preparation for its domestic finance, and (iii) China gained a lot of benefit from the two recent decades

There is an endless argument on finance-growth nexus Various researches capture different effect of finance on growth There are positive, negative, and irrelevant relations between financial development and economic development reported by numerous empirical works Generally, researches conducted on aggregate level usually investigate in panel data while time-series analysis is mostly employed in micro researches As panel data at aggregate level, previous studies targeted to examine a typical influence of finance on growth or vice versa This kind of research cannot isolate a special case like China in order to shield the light to a particular puzzle As micro data level, research can capture particular picture of targeted market Even that, microdata is better to focus on special sector or market within an economy

It is not very useful to apply microdata in a research for the whole economy Moreover, employing aggregate data in time-series analysis will suffer many econometric issues as well as be criticized on its reliability Regardless these preventions, some studies conducted time-series analysis with aggregate data Most of them try to achieve to high frequent data like quarterly or monthly data These database usually available for researching on trade, exchange rate, and interest rate There are rely researches employed yearly data to explore finance & growth nexus for

a single country

The motivation for this study is the rapid development of China in two recent decades We try to shield the light on finance & growth nexus in China, especially the growth effect of financial integration This research try to contribute empirical evidence for the finance-growth nexus under time-series point of view for a single nation at aggregate level, by employing the recently updated data on financial integration which is firstly developed by Dreher (2006) The data sets up financial

integration as two separated terms: de facto and de jure

We try to figure out the long-term cointegration between financial integration and economic growth in China by employing the Cobb-Douglas production function Regardless critics on limit observation in time-series analysis, we utilize ARDL model

in order to discover and examine cointegration relationship between financial integration and economic growth within a small data sample To convince our results,

we also employ typical diagnostic tests for time-series analysis, especially for ARDL model The results indicate that there is a long-term cointegration between financial integration and economic growth in China Moreover, through Granger causality test, bidirectional causality between economic growth and financial integration in China is founded The study then confirm an important role of financial integration and Chinese government regulation to foster Chinese economy in the two recent decades Besides that, we also endorse a complex interaction between financial development and economic development via the bidirectional causality of the financial integration and economic growth in China

2 Literature review

2.1 Relationship between financial development and economic growth

An intensive literature review has been conducted on the finance-growth nexus

There are two separated channels in which finance affects to economic growth: (i) capital accumulation and (ii) total factor of productivity (TFP) Financial development

including financial integration can affect to economic growth toward the both chanels The financial integration with other countries in the region and the world can affect capital accumulation through foreign direct investment or external debts As in the TFP channel, the innovation of international finance as well as the participation of foreign (or domestic) investors to national (or global market) directly or indirectly response to regulation on financial integration Therefore, financial integration can influence economic development With regard to financial development, the literature has been developed from financial depth or financial stabilty to more broaden concepts such as financial liberalization, financial inclussion and financial integration Traced back the theory, there are various perspectives on the finance-growth nexus On the one hand, Levine (2005), Levine, Loayza and Beck (2000), Levine and Zervos (1998), King and Levine (1993), and Schumpeter (1911) argued that the development of financial market is an important factor to foster economic development For example, capital resources can be efficiently allocate to productive

users in a well-developed financial system Then economic growth would be increased

as a result Inversely, Robinson (1952) argued that financial development passively responses to economic growth due to the increase of financial demand

Patrick (1966) studied the demand-following and supply-leading aspects of finance-growth nexus The author argues that the process of economic development over time, in a marketoriented economy using the price mechanism to allocate resources, is an increase in the number and variety of financial institutions and a substantial rise in the proportion not only of money but also of the total of all financial assets relative to economic growth and to tangible wealth However, the author also emphasizes the lack of theoretical and empirical researches on the finance-growth nexus at that period After that, Gregorio and Guidotti (1995) examine the long-run relationship between growth and financial development They find a positively correlation between financial development and economic growth in a large cross-country sample However, the effect changes across countries, and is negative in a panel data for Latin America The author claim that the latter findings is the consequence of financial liberalization in a week regulatory legal system Besides that, Gregorio and Guidotti (1995) also indicate that the main channel of transmission from financial development to growth is the efficiency, rather than the volume, of investment

Arestis and Demetriades (2012) examine the empirical literature of

finance-growth nexus from two angles The first is the issue of whether, how and to what extent the financial system can contribute to the process of economic growth Questions about the association amongst financial deepening, investment, and the efficiency of capital fall in this category The question of causality between finance and growth can also be considered from this perspective The second angle relates to the question of whether financial liberalisation can stimulate investment and growth Evidence on this question has been adduced from countries where financial reforms took place There is, also, a voluminous econometric evidence purporting to address this question by examining interest rate elasticities in saving, investment and growth equations The results warned against the over-simplified nature of results obtained from cross-country regressions in that they may not accurately reflect individual country circumstances such as the institutional structure of the financial system, the

policy regime and the degree of effective governance The econometric evidence using time-series estimations on individual countries suggests that the results exhibit substantial variation across countries, even when the same variables and estimation methods are used Thus, the ‘average’ country for which cross-country regressions must, presumably, relate to may well not exist The authors suggest that the empirical links between stock market development and economic growth warrant further investigation Specifically, examining the impact of financial liberalisation on stock market volatility and the effects of the latter on investment and growth seem to us to

be a promising avenue for future research

There are also two opposite schools of thoughts arguing the role of financial restrictions The economist from the Schumpeterian pespective agreed that a developed financial system toward the competitive maket mechanism encourages economic development (Ang & Mckibbin, 2007; Gurley & Shaw, 1955; Goldsmith, 1969; and Hicks, 1969) The creation and innovation of financial markets, services, and products force the saving-investing cycle to perform more efficiently However, from the Keynesian point of view (e.g Studart, 1993; Loizos, 2018; Xu & Gui, 2019),

an expanded financial market with various participations will lower the role of the government Lack of supervision and regulation from the government to financial system create a risk of instability and an ease-to-attack system Thus, financial market requires a repression or strict supervision for its security and stability High level of compulsory reserves, controlling the interest rate or exchange rate can be considered

as effective repression on the financial system As a result, Keynesian economists argue that financial repression is better than the liberalized one for economic development throughout stabilizing effect

After a well expansion of the Keynesian school of thoughts, McKinnon (1973) and Shaw (1973)1 challenged the ideology of the requirement of regulation and supervision for financial market McKinnon-Shaw school of thoughts support applying competitive market mechanism for financial system The term ‘financial

1 who are acknowledged as pioneers of the idea of financial liberalization in which emphasizes the crucial role of financial development to enhance economic development

liberalization’ has been ermerged since that ‘Financial liberalization’ implies a financial system in which interest rate as an example can be adjusted by the market itself, and the system will efficiently processes Later on, Ang (2008b) Durusu-Ciftci, Ispir, and Yetkiner (2017), Fry (1989), Levine (2005), Levine, Loayza and Beck (2000), Levine and Zervos, 1998, and King and Levine (1993) criticized the policies related to financial repression which leads ineffectively financial allocation

2.2 The role of integration and liberalization in financial system

Financial integration could be considered as an aspect of a financial development The concept of ‘integration’ is relatively closed to ‘liberalization’ However, the process of integration implies the expansion of (or the mixture between) domestic to the global financial systems The term of liberalization, on the other hand, expresses how dynamic the market could be On other words, financial integration emphasizes a level of a globalized financial system, and financial liberalization suggests a free-regulated financial system

At aggregated level, majority of reaches explored financial integration as the term of financial globalization or financial liberalization, and discussed on the relations between these interests and financial development or economic development (Beck et al., 2000; Bekaert et al., 2005; and Eichengreen et al., 2003) There is rarely evidence of growth effects directly deriving from financial integration for neither within country nor cross nations analysis at aggregated level Kose et al (2003) found

a positive impact of financial openness on the ratio of consumption volatility to income volatility through both OLS and IV regressions Gourinchas and Jeanne (2006) concluded an association between financial integration and improvement of social welfare in developing countries Dreher (2006) conducted an extensive data on globalization The author growth effect of globalization involving financial globalization

Many studies found complexity in the finance-growth nexus, espesically in the relationship between finanacial integration and economic growth For example, Ang (2008b) found a complex relationship between finance-growth nexus in Malaysia While, the development financial market encourages economic growth, the regulation

of Malaysian government on the domestic financial system has negative effect on its economic growth Anwar and Sun (2011), on the other hand, exhibited a positive relationship between financial development and capital stock but not with economic growth in Malaysia In terms of cross countries analysis, Bussière and Fratzscher (2008) argued that countries would gain benefit from liberalizing their financial system in short-term However, economic growth would face diminishing return from financial liberalization after that Negative economic growth can potentially happen in the long run Wolde-Rufael (2009) found bidirectional causal relationship between financial development and economic growth in Kenya Recently, on the basis of Dreher (2006) and Dreher et al (2008), Gygli et al (2019) improved the dataset on globalization, and found gowth effect of globalization involving financial globalization

Imbs (2004) investigates in the role of financial integration on economic growth Finance serves to increase international correlations in both consumption and GDP fluctuations, which explains the persistent gap between the two in the data, a “quantity puzzle” The positive association between financial integration and GDP correlation constitutes a puzzle, as theory suggests a negative relation if anything Nevertheless, it prevails in the data even after the effects of finance on trade and specialization are accounted for

Empirically, the main direction of researches on financial integration in China still focuses on bilateral response between the Chinese stock market and other stock markets in different countries Most of results did not suggest an empirical evidences about the integration between prices in Chinese stock market and in other markets like

US, Tai Wan, Hong Kong (Girardin & Liu, 2007; Groenewold, Tang, & Wu, 2004; Hatemi & Roca, 2004; and Huang, Yang, & Hu, 2000 ) These studies employed high level of frequency data as usually is daily and weekly data in the framework of time-series analysis

In other point of view, Girardin & Liu (2007) discussed on the de jure term of

financial integration, and found cointegrated relationship between the Shanghai market and the S&P 500 market Statistically, Okazaki and Fukumoto (2011) emphasized the role of finance in the development of and the protection of the

Chinese economy in recent decades The authors argued for the important role of financial development as well as Chinese government regulation on its financial system in its development process

Based on these ground, theory does not clearly support an influence of financial integration to economic development, and empirical works are still arguing on this confused relationship This paper aims to explore cointegration relationship between financial integration and economic growth in China at aggregated level Moreover, we pay an interest on whether financial integration inducing China as the second largest economy, recently

3 Methodology and data

3.1 Methodology

In accordance with various studies, the aggregate output is considered as proxy representing for economic growth Ang (2008a, and 2008b), Anwar and Sun (2011), Arestis et al (2014), Greenwood and Jovanovic (1990), Gurley and Shaw (1955), and King and Levine (1993) employed the Cobb-Douglas production function in the literature of economic growth The function can be expressed as follows:

(1)

where:

Y stands for GDP at time;

TFP denotes the total factor of productivity;

K stands domestic capital;

L denotes labour force; and

αi (i = 1, 2, 3) stands for the elasticity of TFP, K, and L, respectively

Various studies used the aggregate production function to discover the growth nexus, in which financial integration as a factor of the TFP In term of conducting the element of TFP, other researches usually separate financial factors from TFP, such as Ang (2010), and Anwar and Sun (2011)

finance-3.2 Time-series analysis strategy

The cointegration relationship between financial integration and economic growth can be discovered by using the two most appropriate methods namely The Vector of auto-regressive (VAR) and the Auto-Regressive Distributed Lags (ARDL) models Ong the one hand, VAR processes a simultaneouse equation system in which each variable is alternatively beeing the dependence As such, the VAR has advantage

to deal with endogenous problems arising in the model Moreover, VAR model will

perform more effectively with large samples It means that the VAR will be the better model if we doing research with quarterly or monthly dataset In addition, Johansen cointegration test based on VAR can test the existence of cointegration relationship among variables in the model

On the other hand, ARDL model based on the Error Correction Mode (ECM) model can report both short and long run coefficients Besides that, compared to the Johansen test for cointegration, ARDL bound test allows to test cointegration with a small sample Moreover, ARDL bound test can process with mixture of variables having I(0) and I(1), while Johansen test restricts that all variables have to be integrated at the same order Furthermore, if the unit root occurred with a structural break, normal unit root test suggested by Augmented Dickey Fuller or the Phillips-Perron tests could yield a misleading rejection Then Johansen cointegration test could also lead a bias conclusion In this case, ARDL bound test has advantage as a better estimation which takes into account structural breaks, regardless the included variables are I(0) or I(1) Therefore, ARDL model is more appropriated in this study comparing to VAR model We develop ARDL model as following:

(4)

(5)

(6)

(7) where:

is short-term effect; and

bj is long-term effects of the regressors

To ensure the efficiency of ARDL model, we need to validate several restrictions

of this model Firstly, all variables need to be I(0) or I(1) Secondly, we need to define whether dependent variable has unit root with structural break or not Thirdly, we need to assure there is no serial correlation in the model meaning that error term exported from regressions should not correlated with its lagged value Last but not least, the model also need to validate some other post-estimated tests to assure its reliability and robustness

Although ARDL model has advantage in identifying cointegration relation among interested variables, it does not assure for a causal relation between independent and dependent variables Ang (2008b), Demetriades and Andrianova (2004), and Diebold (2004) argued that causality in time-series analysis is not appropriated These authors proposed that the term ‘causality’ was a glossy implication of the ‘prediction power’ of variable X, which contains meaningful historical information, to predict variable Y However, most researches using time-series analysis with a single national data try to figure out this critical causality in order to contribute some policy implications The literature review indicates that time-series analysis with data for a country can also be used to examine the causality of the variables Thus, we propose to use Granger causality test to identify if financial integration has causal relationship with economic growth in China

3.3 Variables and data sources

We has not found a formally unique measurement of financial integration for a single country or cross-nation researches There are typically three measurements setting up to quantify financial integration in the literature: (i) the single represented variable (Ang, 2008a & 2008b; and Anwar & Cooray, 2012), (ii) the multi-variables (Anwar & Sun, 2011; and Wolde-Rufael, 2009), (iii) and the computed index (Dreher, 2006; Dreher et al., 2008; and Gygli et al., 2019) The first suggestion is the most simple measurement, however it is widely criticized as a poor quality of representativeness Because it cannot capture different aspects of financial integration For the second solution, the multi-variables measurement uses a category of indices to represent for different characteristics of financial integration This method has advantages to the first solution However, the multi-variables measurement can use too much variables in regression model Thus, we can potentially suffer multi-correlated problem and autocorrelation issue in the regression

On the ground above, the latest suggestion for measuring financial integration seems to overcome weakness of the two early options Computing an index from various variables in order to score the level of financial integration can take into account many aspects of financial integration as a single variable Moreover, the index can resolve the problem of multi-correlation and autocorrelation as excluding the existence of many relevant variables in regression model However, the index has its own issue of representativeness Index is a relative measurement instead of absolute one This issue is a common problem of relative measurement such as economic growth rate, trade openness index, and many others Indexed measurement focuses on qualitative character of the objective, while the absolute term indicates quantitative aspect of the interested variable For example, trade openness of China in 2017 was 37.8% The number means that total value of trade including import and export of China account for 37.8% percentage of the Chinese GDP in 2017 It means how large trading contributes to Chinese economy However, the index cannot express actuall value in term of million US dollar of China trading in the year of 2017 Thus, the index of financial integration can also face with the problem of measurement