INTRODUCTION
Research problem
Recent studies have increasingly focused on the causal relationship between financial development and economic growth, highlighting the significant role that financial development plays in fostering economic growth (Feng Lu & Yao, 2009; Fung, 2009; Fase & Abma, 2003; Ang & McKibbin, 2007).
Financial development boosts economic growth by improving capital allocation efficiency This efficiency is achieved through the roles of financial intermediaries, which enhance risk management, reduce asymmetric information, and promote saving and investment Consequently, this leads to an increase in total factor productivity Thus, a well-functioning financial system is essential for fostering economic growth.
There are numerous empirical studies providing supportive evidences on positive linkage between financial development and economic growth (Fung, 2009; Anwar &
Research by Calderón and Liu (2003) utilized the Vector Auto Regression (VAR) approach to analyze panel data from 109 industrial and developing countries between 1960 and 1994, revealing a positive causal relationship between financial development and economic growth Their findings indicate that financial development not only fosters economic growth but is also influenced by it, primarily through rapid capital accumulation and productivity growth The authors emphasized the importance of recognizing the impact of financial development on economic growth to inform effective policy-making.
Page 2 enable them to obtain a higher economic growth and development (Calderón and Liu,
Habibullah and Eng (2006) examined the causal link between financial development and economic growth in 13 less developed Asian countries from 1990 to 1998 Their findings indicate that financial development significantly boosts economic growth The authors emphasized that a well-developed financial system generates a variety of financial instruments, which enhance capital accumulation by mobilizing savings, improving investment efficiency, and increasing total factor productivity.
Al-Yousif (2002) utilized the Granger causality test within an error correction model to explore the relationship between financial development and economic growth in thirty developing countries The study revealed that a dysfunctional financial system adversely affects real GDP growth, primarily due to the inefficient allocation of savings and investments during the 1980s.
This means that there is a same direction movement on the relationship between financial development and economic growth
The causal relationship between financial development and economic growth remains ambiguous, as indicated by various studies This uncertainty has led to significant debate within the literature.
In their 2011 study, Hassan et al explored the relationship between financial depth and economic growth across various income groups, including low, middle, upper-middle, and high-income countries, over the period from 1980 to 2007 The results revealed that financial development has a weak impact on short-term economic growth in developing regions, as supported by findings from Wu et al (2010) and Ghirmay (2004).
This thesis re-examines the causal relationship between finance and economic growth using econometric techniques to measure financial depth and growth Employing a new dataset, the study aims to provide additional evidence on how financial development impacts economic growth The analysis focuses on twenty-two developing countries from various regions, including Malaysia, China, Indonesia, and Turkey, over the observation period from 1990 to 2011 The dataset is sourced from the World Development Indicators (WDI) provided by the World Bank.
The selection of twenty two developing countries over period 1990-2011 has several reasons:
Financial development plays a crucial role in driving economic growth in developed countries, while its influence is considerably weaker in developing nations This disparity highlights the need for further investigation into the causal relationship between financial development and economic growth specifically within developing countries.
- The second is that the choice of sampled developing countries has an advantage in providing policy implications (Hassan et al., 2011)
The third reason for this research is the availability of an annual panel data set from twenty-two developing countries spanning the period from 1990 to 2011 This dataset enables a comprehensive examination of the long-term, two-way impacts of the finance-growth relationship, while also providing sufficient observations to conduct effective econometric analysis aligned with the research objectives.
This research investigates the causal relationship between financial development and economic growth We develop a growth equation that incorporates elements of financial development, a framework commonly utilized in empirical literature.
This article provides an overview of the relationship between financial development and economic growth in Vietnam, comparing its analysis results with those of other developing countries, particularly selected Asian nations such as Indonesia, Malaysia, the Philippines, Thailand, China, and Singapore, during the period from 1990 to 2011.
This research aims to leverage the beneficial relationship between financial development and economic growth, offering valuable policy recommendations for Vietnamese policymakers By promoting financial development, Vietnam can achieve enhanced economic growth.
Research objectives and research questions
This research mainly focuses on the following objectives:
- Examining the causal relationship between financial development and economic growth in twenty two developing countries from different regions for the period of
- Providing appropriate policy implications to Vietnamese policy makers for promoting financial development that will enable Vietnam to have higher economic growth
This research focuses on exploring the causal relationship between financial development and economic growth Key questions arise from this investigation, guiding the analysis of these critical issues.
Financial development plays a crucial role in promoting economic growth, while economic growth can also enhance financial development This reciprocal relationship highlights the importance of a robust financial system in facilitating investment and resource allocation, ultimately driving economic progress.
- How does development of financial sector contribute to causal relationships?
Thesis Structure
This thesis is divided into five chapters
Chapter 1: Introduction explains what causal relationship between financial development and economic growth is and scientific literatures related to the problem to be investigated It also presents different point of views on the relationship between financial development and economic growth from numerous empirical studies Finally, it explains why twenty two developing countries are selected, what main objectives are, what research questions should be raised in this thesis
Chapter 2: Literature review provides a review of economic theories relating to the causal relationship between financial development and economic growth This part describes theoretical framework and empirical studies related to the issue The determinants of economic growth and financial development are mentioned in this part
Chapter 3: Methodology is concerned with general methods and how to examine causal relationship between financial development and economic growth, which mainly involves following points:
- analytical framework for the problem to be investigated
- research hypotheses to be tested
- variables or factors to be described to answer each research question
- panel dataset and sample to be used to examine the causal finance-growth relationship
- method and technique to be used for processing and analyzing information
- estimated regression models to be applied to test hypothesis and answer research questions
Chapter 4: Estimation Analysis and Findings focuses on analyzing the estimation results and result interpretation on how the economic growth effect on development of finance system and vice versa tot nghiep down load thyj uyi pl aluan van full moi nhat z z vbhtj mk gmail.com Luan van retey thac si cdeg jg hg
Chapter 5: Conclusions and Implications comes to the main findings of the research
This section provides an overview of the relationship between financial development and economic growth in Vietnam, comparing its outcomes with those of other developing countries, particularly in Asia.
Indonesia, Malaysia, Philippines, Thailand, China, Singapore) which having the same financial characteristics as Vietnam
This research aims to leverage the beneficial relationship between financial development and economic growth in developing countries, offering valuable policy recommendations for Vietnamese policymakers By promoting financial development, Vietnam can achieve enhanced economic growth.
LITERATURE REVIEW
Theoretical concepts related to economic growth and financial development
Financial development is defined that (Kunt and Levine 2008, p 4-5):
Financial development takes place when financial instruments, markets, and intermediaries improve, though not completely remove, the impacts of information, enforcement, and transaction costs, thereby enhancing their ability to effectively deliver the five essential financial functions.
The five main functions of financial system are mobilizing savings, allocating financial resources, assessing and managing risks, monitoring businesses and facilitating goods and services movement (Kunt and Levine, 2008, p.4-5)
Economic growth is defined that (Perkins et al., 2006, p 12):
Economic growth occurs when a country's production of goods and services increases, leading to a rise in national or per capita income This growth can be achieved through various means, ultimately resulting in higher average income for the population.
Gross domestic product (GDP) or Gross national product (GNP) are uasualy used to measure Economic growth.
Financial development and economic growth: theoretical literatures
The financial system plays a crucial role in economic growth by influencing the allocation of savings and investment decisions According to Levine (2005), its functions can be categorized into five key areas.
- Allocating financial resources and reducing information asymmetry
- Mobilizing or pooling savings tot nghiep down load thyj uyi pl aluan van full moi nhat z z vbhtj mk gmail.com Luan van retey thac si cdeg jg hg
- Easing the goods and services flow
2.2.1.1 Allocating financial resources and reducing information asymmetry
Investing involves significant transaction costs due to the need to evaluate businesses and their environments These high costs can elevate the overall expense of utilizing financial resources Additionally, in a context of scarce capital, limited information about economic conditions can lead investors to face increased costs associated with accessing business activities and understanding economic factors (Levine, 2005).
Financial intermediaries play a crucial role in minimizing transaction costs and addressing information asymmetry in investment opportunities According to Levine (2005), their involvement is essential for enhancing market efficiency and facilitating smoother financial transactions.
Efficient financial intermediaries significantly reduce the costs associated with acquiring and processing information, leading to lower transaction costs and improved capital flow into profitable projects This enhancement in financial market efficiency promotes fund mobilization and investment, ultimately boosting production efficiency in the commodity market (Levine, 2005) Levine also highlights that a financial market characterized by low transaction costs and high liquidity fosters technological innovation by incentivizing investors with promising projects Furthermore, Zagorchev et al (2011) assert that technological innovation accelerates business activities by improving information acquisition and processing Consequently, increased production and the effective use of technology in reducing information processing costs enhance capital resource allocation, thereby driving economic growth (Zagorchev et al., 2011; Levine, 2005).
Finally, due to less information asymmetry, the financial resources will be effectively allocated; hence, the economic growth will be improved in both short and long run (Levine, 2005)
Mobilizing savings involves the expensive task of gathering capital from various lenders or savers for investment purposes This process presents two significant challenges: first, the high costs associated with acquiring and processing information necessary to attract funds from a diverse group of savers and investors; and second, the issue of information asymmetry, where savers or investors may lack critical information needed to make informed investment decisions (Levine, 2005).
Levine (2005) identifies two primary methods for bridging savings and investments The direct method involves mobilizing funds from various sources, including joint stock companies, enterprises, and individual savers In this approach, capital flows directly from those with surplus resources to those seeking funds for profitable investments.
This direct mobilization may cause the fact that the lenders have to deal with the considerable transaction cost involving assessing business activities, investment opportunities and economic condition
Mobilizing funds through financial intermediaries is an effective strategy for bridging savings and investments These intermediaries utilize capital from savers and investors to inject funds into financial markets, which helps to economize on transaction costs and reduce information asymmetry This approach also addresses the indivisibility of investments, ultimately accelerating economic growth by leveraging economies of scale (Levine, 2005).
Levine (2005) highlights that mobilizing savings can optimize resource allocation and foster technological innovation Without funding from various investors, many production processes risk relying on outdated technology.
Inefficient economies of scale can constrain production processes (Levine, 2005) Better mobilization and allocation of funds from society enable risk pooling and diversification among savers and investors through various financial instruments This sharing and transferring of risks can prevent capital from being redirected to higher-return projects, ultimately leading to a positive acceleration in economic growth (Levine, 2005).
Levine (2005) highlights that risks are an integral part of every financial transaction, stemming from information and transaction costs Financial contracts, markets, and intermediaries are crucial for effective resource allocation, enabling the trading, sharing, and shifting of risks between savers and investors, which supports economic growth He categorizes risk into three types: cross-sectional risk diversification, intertemporal payoff sharing risk, and liquidity risk.
Financial institutions such as commercial banks, investment banks, mutual funds, and insurance companies can effectively diversify cross-sectional risks By offering various financial instruments for trading, pooling, hedging, and risk-sharing, these entities can allocate resources more efficiently and transfer risks from high-risk projects to those with lower risk profiles (Levine, 2005).
Financial intermediaries offer risk diversification tools that encourage savers and investors to engage in riskier ventures with the potential for higher returns.
Financial systems play a crucial role in promoting long-term economic growth by offering risk diversification tools that enhance resource allocation and savings rates In environments where capital is limited, investors tend to avoid risk, leading to the understanding that projects with higher expected returns are often associated with greater risk.
During economic recessions, intertemporal risks are often not diversifiable at a specific moment Financial intermediaries play a crucial role in mitigating these risks, particularly during economic shocks They can effectively diversify intertemporal risk by reducing contracting costs, as noted by Levine (2005).
Liquidity risk refers to the challenge of converting financial instruments into cash quickly Levine (2005) highlights that this risk arises from uncertainties linked to information asymmetries and transaction costs When transaction costs are high and information is unevenly distributed, the liquidity of financial instruments diminishes, leading to an increase in liquidity risk.
Literature review and empirical studies
Levine (1997) modeled the causal relationship between economic growth and financial development as follows:
GROWTHj : represented by GDP growth rate at j th in ranking
Financial development is represented by key determinants, including the liquid liability to GDP ratio (DEPTH), the ratio of bank credit to domestic money banks and central bank domestic credit (BANK), the ratio of credit to the private sector relative to GDP (PRIVY), and the ratio of credit to the non-private sector within domestic credit (PRIVATE).
The explanatory variables of economic growth, denoted as X, include the secondary school enrollment rate, the ratio of government consumption spending to GDP, the inflation rate, and trade openness The error term is represented by Ε Additionally, Hassan et al (2011) established a model to illustrate the relationship between finance and growth.
GROWTHi,t = f(FINi,t, GDSi,t, TRADEi,t, GOVi,t, INFi,t, εi,t )
Financial development, denoted as FIN, encompasses various components including DCBS, DCPS, and M3 In this context, \(i\) represents a specific country and \(t\) indicates a particular time period The term \(\varepsilon_{i,t}\) signifies the error term in the analysis.
Hassan et al.,(2011) suggested that there are seven economic indicators capturing financial depth and economic growth These economic indicators are:
(i) Domestic credit provided by banking sector measured in percentage of GDP
The Domestic Credit to the Private Sector (DCBS) ratio indicates effective financial system functions, which positively influence financial development (Levine, 1997) Additionally, Hassan et al (2011) argue that a higher DCBS ratio necessitates greater financial development, as banks are required to fulfill five essential financial functions.
(ii) Domestic credit to private sector measured in percentage of GDP (DCPS)
The allocation of capital resources to the private sector necessitates advancements in the financial system For effective capital allocation, it is essential that five key financial functions are executed proficiently: assessing and managing risks, monitoring businesses, facilitating financial transactions, and promoting savings (Hassan et al., 2011).
(iii) Broadest definition of money measured in percentage of GDP (M3)
A higher liquidity ratio is often associated with greater development in the financial system, as it reflects the system's capacity to offer saving opportunities and facilitate financial transactions (Hassan et al., 2011; Jeanneney & Kpodar, 2011).
(iv) Gross domestic saving measured in percentage of GDP (GDS)
Financial deepening plays a crucial role in promoting economic growth by effectively channeling savings into investments As the ratio of gross domestic savings to GDP rises, it leads to an increase in investment volume This improvement positively influences real interest rates, further stimulating both investment and overall economic growth (Hassan et al., 2011).
Trade openness, represented as a percentage of GDP (TRADE), plays a crucial role in economic performance and development It reflects the extent to which a country engages in international trade, influencing growth and competitiveness in the global market.
The ratio of the sum of imports and exports of goods and services as a percentage of GDP plays a crucial role in enhancing economic growth by promoting international trade openness (Hassan et al., 2011).
(vi) General government final consumption expenditure measured in percentage of
GDP (GOV) plays a crucial role in enhancing economic growth by adjusting government spending It is anticipated that this indicator will move inversely to economic growth due to the crowding out effect, where public investments negatively impact private investment and consumption (Zagorchev, A., Vasconcellos, G., & Bae, Y., 2011).
This indicator is used to control price changing
This research proposes a fundamental equation to illustrate the causal relationship between financial development and economic growth, building on previous empirical studies in this area.
In which, GROWTHit : Growth rate of GDP per capita
FDit : The indicators of financial development
Key indicators of financial development include the ratio of broad money to GDP, the ratio of bank credit to the private sector relative to GDP, the ratio of domestic credit to the private sector as a percentage of GDP, and gross domestic savings expressed as a percentage of GDP.
Xit : The group of determinant variables of economic growth
Key variables influencing economic performance include Foreign Direct Investment (FDI), General Government Consumption, and Trade Openness, which is assessed by the total of imports and exports of goods.
Page 22 εit : Error term i,t : Country i and time t respectively αs : Coefficient of independent variables
2.3.2 Empirical studies on financial development and economic growth relationship
Levine et al., (2000) highlighted the need to use ratio of credits offered by banks to private sector to GDP as one of key components in measuring financial development
The authors, Levine et al (2000), posited that a higher level of financial services correlates with greater financial development Utilizing the generalized method of moments with pure cross-sectional instrumental variables, they examined the finance-growth relationship across 74 countries from 1960 to 1995 Their findings revealed two key insights: first, the components of financial development—such as the ratio of bank credits to the private sector relative to GDP, the ratio of commercial bank assets to the total of commercial and central bank assets, and the liquid liabilities of the financial system—exhibit a positive correlation with economic growth.
Secondly, the causal correlation between financial development and economic growth mainly rely on the growth of total factor productivity (Levine et al., 2000)
In a 2002 study by Khalifa Al-Yousif, the Granger test was utilized within an error correction model (ECM) to explore the relationship between financial intermediation and economic growth in 30 developing countries from 1970 to 1999 The findings indicated a positive two-way relationship between financial development and economic growth Additionally, the study identified two key indicators for assessing financial depth: the ratio of narrow money stock to GDP (M1) and the ratio of broad money to GDP (M2) It was suggested that an expansion in the financial sector leads to increased utilization of financial services, thereby enhancing financial development.
METHODOLOGY
General methods
3.1.1 Conceptual framework for the study Figure 1: The relationship between financial development and economic growth
A well-functioning financial system plays a crucial role in driving economic growth, while economic growth simultaneously incentivizes the further development of the financial system.
The financial system serves five essential functions: mobilizing savings, allocating financial resources, assessing and managing risks, monitoring businesses, and facilitating the movement of goods and services (Levine, 1997) When these functions are effectively executed, they can significantly enhance economic growth through two primary channels, starting with capital.
Increase financial depth, reduce transaction cost
Screen and support efficient investment
Reduce risk and asymmetric information
Well functioning of financial system
Increase economic growth tot nghiep down load thyj uyi pl aluan van full moi nhat z z vbhtj mk gmail.com Luan van retey thac si cdeg jg hg
Page 33 accumulation and the second one is through technology innovation (Zagorchev et al., 2011; Levine, 1997; Calderón and Liu, 2003)
An effective financial system enhances capital accumulation by providing instruments that improve financial development, lower information and transaction costs, and support efficient investments while mitigating risks and asymmetric information This process facilitates the sharing and transfer of various risks between savers and investors, ultimately leading to increased capital accumulation in both savings and investments Consequently, this rise in capital accumulation positively influences economic growth.
Technological innovation plays a crucial role in boosting economic activity by leveraging advanced technology, which in turn increases total factor productivity This rise in productivity significantly contributes to economic growth (Levine, 1997; Zagorchev et al., 2011; Hao, 2006) Furthermore, Levine (1997) highlights that higher economic growth necessitates increased capital to support production activities, thereby creating a demand for more efficient capital utilization Consequently, economic growth serves as a catalyst for enhancing financial development through the expansion of financial institutions.
Zagorchev et al., 2011; Hao, 2006; Ghirmay, 2004; Calderón and Liu, 2003)
The hypotheses are intended to test in this research are follows:
- Hypothesis 1: Financial development positively impacts on economic growth
- Hypothesis 2: Economic growth positively impacts on financial development
Foreign Direct Investment (FDI) has a positive impact on economic growth.
- Hypothesis 4: General government consumption negatively impacts on economic growth
- Hypothesis 5: Trade openness and gross domestic saving positively contribute to financial development and economic growth
Hypothesis 6 posits that the ratio of broad money to GDP, the ratio of bank credit to the private sector relative to GDP, the ratio of domestic credit to the private sector as a percentage of GDP, and gross domestic savings as a percentage of GDP all positively influence financial development.
The expected signs of variables are described in Table 2
Table 2: Expected signs of variables:
Explanatory Variables Dependent variable: Expected sign:
Impact of: on Economic Growth
(2011) tot nghiep down load thyj uyi pl aluan van full moi nhat z z vbhtj mk gmail.com Luan van retey thac si cdeg jg hg
Impact of: on Financial Development
GROSSDSA Positive Hassan et al.,(2011) tot nghiep down load thyj uyi pl aluan van full moi nhat z z vbhtj mk gmail.com Luan van retey thac si cdeg jg hg
DOMCREDIT/GDP Positive Hassan et al.,(2011)
Research models and econometric methodology
Based on the theoretical arguments described as aboved, our study mainly investigates the interaction of financial development and economic growth via the channel of capital accumulation
In line with the objectives as presented in this research, the estimated regression equations on examining the causal finance-growth relationship are suggested as follows:
- First regression function: Effect of financial development (FD) on economic growth (EG):
Examining whether financial development (FD) impacts on economic growth (EG):
EG it = α o + α 1 FDit + α 2 FDI it + α3GOV it + α 4 TRAO it + α 5 GDPGRTH it-1 + ε it
The second regression function examines the impact of economic growth (EG) on financial development (FD) This analysis aims to understand how variations in economic growth influence the progression and stability of financial systems.
Investigating whether economic growth (EG) affects on financial development (FD):
FD it = β o + β 1 EG it + β 2 M2/GDP it + β 3 BANKCREDIT/GDP it + β 4 DOMCREDIT/GDP it + β 5 GROSSDSA it + σ it
Masten et al (2008) emphasized the importance of incorporating lagged GDP per capita growth into the growth estimation equation to effectively capture the persistence of economic growth.
The explanatory variables and dependent variables are defined in Table 3 as follow:
EG Growth rate of real GDP per capita percentage growth rate of GDP
GDPGRTH t-1 Lagged one year GDP per capita growth Annual percentage growth rate of GDP
FD Financial development Percent of GDP
M2/GDP Ratio of Broad money to GDP Percent of GDP
BANKCREDIT/GDP Ratio of credit offered by bank to private sector to GDP
DOMCREDIT/GDP Ratio of domestic credit to private sector to GDP
GROSSDSA Gross domestic saving as percentage of
FDI Foreign direct investment Percent of GDP
GOV General government consumption Percent of GDP
TRAO Trade openness measured by the sum of import and export of goods
Percent of GDP tot nghiep down load thyj uyi pl aluan van full moi nhat z z vbhtj mk gmail.com Luan van retey thac si cdeg jg hg
Country sample (N"): developing countries from different regions (See Appendix B)
Observed period is from 1990 to 2011
Various methods are utilized to explore the causal link between financial development and economic growth, such as the generalized method of moments using pure cross-sectional instrumental variables, as demonstrated by Levine et al (2000).
Several studies have employed various econometric methods to analyze time series data, including the Granger test within an error correction model (ECM) by Khalifa Al-Yousif (2002), the Geweke decomposition test utilized by Calderón and Liu (2003), and multivariate time series analysis conducted by Hassan et al (2011) Additionally, Lee and Chang (2009) applied dynamic OLS and vector error correction models, while Christopoulos and Tsionas focused on panel unit root and cointegration tests.
Empirical studies indicate that the variables used to explore the causal relationship between financial development and economic growth are often endogenous (Levine et al., 2000; Zagorchev et al., 2011; Habibullah and Eng, 2006; Masten et al., 2008) To address biases from inconsistent regression coefficient estimates, Zagorchev et al (2011) and Masten et al (2008) suggest using the generalized method of moments (GMM) with instrumental variables, as ordinary least squares (OLS) may not adequately correct for these issues when endogenous regressors are present This inadequacy arises from violations of the orthogonality condition between the error term and explanatory variables (Zagorchev et al., 2011; Masten et al., 2008).
This study employs the generalized method of moments with instrumental variables and pooled ordinary least squares (OLS) to investigate the causal relationship between finance and growth in selected developing countries, covering the period from 1990 to 2011.
Panel data offers two key advantages: it enables control over unobservable variables and those that vary over time but not across entities, addressing individual heterogeneity Additionally, by integrating time series and cross-sectional observations, panel data enhances information richness, providing greater degrees of freedom and improved efficiency in analysis.
The Generalized Method of Moments (GMM), introduced by L Hansen in 1982, has become a crucial tool for empirical researchers over the past two decades, particularly for addressing endogeneity issues (Baum, C F., Schaffer, M E., & Stillman, S., 2003; 2007) This method, which incorporates instrumental variables, does not necessitate specific distributional assumptions for error terms Instead, it fundamentally relies on the premise that there is no correlation between instrumental regressors and the error terms in the equations (Baum, C F., Schaffer, M E., & Stillman, S., 2003).
With an observed annual panel data setting, We begin with the equations on investigating the estimated causal relationship between economic growth and financial development as below:
- First regression function: Effect of financial development (FD) on growth (EG):
Examining whether financial development impacts on economic growth:
EG it = α o + α 1 FD it + α 2 FDI it + α 3 GOV it + α 4 TRAO it + α 5 GDPGRTH it-1 + ε it (1)
- Second regression function: Effect of Economic growth (EG) on Financial development (FD):
This article explores the relationship between economic growth and financial development, examining how changes in the economy can influence the financial sector's evolution It aims to provide insights into the dynamics of economic progress and its impact on financial systems.
FD it = β o + β 1 EG it + β 2 M2/GDP it + β 3 BANKCREDIT/GDP it + β 4 DOMCREDIT/GDP it + β 5 GROSSDSA it + σ it (2) 3.2.2.1 Examining the effect of economic growth on finanacial development
The equation (2) can be expressed in the general form as:
Financial development, denoted as Y, is assessed through a combination of key indicators These include the ratio of broad money to GDP (M2/GDP), the ratio of bank credit to the private sector relative to GDP (BANKCREDIT/GDP), the ratio of domestic credit to the private sector compared to GDP (DOMCREDIT/GDP), and the gross domestic savings as a percentage of GDP (GROSSDSA) for a specific country i in year t.
The set of economic growth determinants, denoted as X, includes Foreign Direct Investment (FDI), General Government Consumption (GOV), Trade Openness (TRAO) measured by the sum of imports and exports of goods, and the one-year lagged GDP per capita growth (GDPGRTHit-1).
Financial development is influenced by several key determinants, including the ratio of broad money to GDP (M2/GDP), the ratio of bank credit to the private sector relative to GDP (BANKCREDIT/GDP), the ratio of domestic credit to the private sector as a percentage of GDP (DOMCREDIT/GDP), and gross domestic savings as a percentage of GDP (GROSSDSA) The model also incorporates an error term (ε), with variables indexed by country (i) and time (t).
Hao (2006) and Zagorchev et al (2011) demonstrate that the error term εit in equation (3) is correlated with the regressor Xit, leading to biased and inconsistent coefficient estimates from the ordinary least squares (OLS) estimator, as noted by Masten et al (2008) and Cameron & Trivedi (2009) This correlation highlights the potential endogeneity of the explanatory variables.
The equations (1) and (2) represent a system where dependent variables are functions of independent variables In the first equation, the dependent variable is financial development (FD), influenced by factors such as foreign direct investment (FDI), government spending (GOV), trade openness (TRAO), and one-year lagged GDP growth The second equation features economic growth (EG) as the dependent variable The variables on the right side of these equations are classified as exogenous, while those that also have their own equations are termed endogenous Specifically, FD is considered endogenous to EG in equation (1), and EG is viewed as endogenous to FD in equation (2).
Endogeneity bias can lead to significant issues in regression analysis, as highlighted by Zagorchev et al (2011), Habibullah and Eng (2006), and Masten et al (2008) When endogeneity bias is present, the ordinary least squares (OLS) method may yield inconsistent and biased estimates of regression coefficients.
Then, OLS estimator can no longer efficiently interpret the causal relationship and the marginal effect on the change of exogenous variables
Data
This research utilizes panel data from twenty-two developing countries, including Malaysia, China, Indonesia, Sri Lanka, Turkey, Egypt, Jordan, Pakistan, Tunisia, Bulgaria, Bolivia, Chile, Mexico, Benin, Cameroon, Thailand, Philippines, Peru, Brazil, Paraguay, Vietnam, and Singapore These countries, situated in various regions worldwide, were observed from 1990 to 2011.
We collect the secondary data from World Development Indicators (2013) from World Bank database The secondary data is retrieved from website http://data.worldbank.org/indicators
The selection of twenty two developing countries over period 1990-2011 has several reasons:
Financial development plays a crucial role in driving economic growth in developed countries, while its influence is considerably weaker in developing nations This disparity highlights the varying effects of financial systems on economic progress across different regions.
2006; Fase and Abma, 2003) Therefore, this research paper focus on investigating the causal relationship between financial development and economic growth in developing countries
- The second is that the choice of sampled developing countries has an advantage in providing policy implications (Hassan et al., 2011)
The third reason for this research is the availability of an annual panel data set from twenty-two developing countries spanning the years 1990 to 2011 This extensive data allows us to thoroughly examine the long-term, two-way impacts of the finance-growth relationship and provides sufficient observations to conduct effective econometric analysis aligned with the study's objectives.
In this study, four components are suggested as the proxies for the financial development
The ratio of Broad Money to GDP (M2/GDP) is a key economic indicator that measures the total currency outside of banks, along with demand deposits, time deposits, and interest-bearing securities held by banks and other financial intermediaries, relative to the Gross Domestic Product (GDP) as defined by World Bank indicators.
A high ratio of broad money to GDP indicates that the financial system is developing, leading to a larger financial sector (Hassan et al., 2011; Calderón & Liu, 2003).
The ratio of bank credit to the private sector relative to GDP (BANKCREDIT/GDP) serves as a key indicator of the financial sector's ability to provide credit across various sectors, including both public and private entities (World Bank Indicator definitions; Giuliano, P., & Ruiz-Arranz, M., 2009) According to Hassan et al (2011), a higher ratio of domestic credit to GDP signifies increased domestic investment, which in turn fosters the development of the financial system For the financial system to effectively allocate more credit to the private sector, it must successfully perform its essential functions, including assessing borrower firms and exercising corporate control.
Page 47 management control, facilitating transactions, and mobilizing savings This requires a higher degree of financial development (Hassan et al., 2011)
Third, the ratio of domestic credit to the private sector to GDP (DOMCREDIT/GDP)
This indicator measure how much financial intermediaries provide financial resources to the private sector for consumption, investment and working capital finance
The ratio of bank credit to the private sector relative to GDP (BANKCREDIT/GDP) serves as an indicator of financial development, suggesting that banks effectively fulfill the five financial functions outlined by Levine (1997) (Hassan et al., 2011).
The ratio of gross domestic saving as a percentage of GDP (GROSSDSA) is calculated by subtracting final total consumption expenditure from GDP, as defined by World Bank indicators A higher percentage of savings allocated for investment is associated with positive economic growth, as investment serves as a key channel through which financial development fosters economic advancement (Hassan et al., 2011).
The determinants used to measure economic growth include:
First, the economic growth is measured by the annual growth rate of the domestic product (GDP) per capita in constant 2005 dollars
The trade openness to GDP ratio (TRAO) is calculated by adding the percentage of imports and exports of goods and services relative to GDP, as defined by World Bank indicators This metric positively influences economic growth by facilitating free international trade activities (Hassan et al., 2011).
The ratio of General Government Final Consumption Expenditure (GOV) as a percentage of GDP is a crucial economic indicator It encompasses all government spending on the purchase of goods and services, as defined by World Bank Indicator definitions.
According to Zagorchev et al (2011), the extent of government deficit is determined by government spending levels To boost private investments, countries often decrease government expenditures and privatize inefficient state-owned enterprises This reduction in government spending is anticipated to have a negative effect on economic growth, primarily due to the crowding out of private investment and consumption.
The ratio of foreign direct investment (FDI) to GDP serves as a key indicator of economic growth, particularly when the financial systems of recipient countries are well-developed According to Lee and Chang (2009), a higher level of financial development enhances the positive impact of FDI on economic growth.
Table 4 provides a concise summary of the variables, including the latest full download data and relevant information related to the thesis.
No Variable Name: Description: Unit Data sources:
1 EG Economic Growth rate Annual percentage of GDP http://data.worldb ank.org/indicators
The determinants of this indicator are:
- Ratio of Broad money to GDP
- Ratio of credit offered by bank to private sector to GDP
- Ratio of domestic credit to private sector to GDP
- Gross domestic saving as percentage of GDP
Percent of GDP http://data.worldb ank.org/indicators
3 FDI Foreign direct investment Percent of GDP http://data.worldb ank.org/indicators
Percent of GDP http://data.worldb ank.org/indicators
5 TRAO Trade openness Peercent of GDP http://data.worldb ank.org/indicators
6 GDPGRTH t-1 One year lagged real GDP per capita growth
The article discusses the annual percentage indicators available on the World Bank's data platform It emphasizes the importance of accessing the latest data for research and analysis Additionally, it highlights the need for proper documentation and academic integrity in the context of thesis writing.
Research process
The activities of this research will be illustrated in three stages:
In the initial phase, we examine pertinent literature related to our topic, focusing on empirical studies that explore the causal relationship between financial development and economic growth Additionally, we define and discuss key concepts to improve comprehension of the subject matter This theoretical framework will assist in establishing a conceptual model for the research issue.
The next phase involves the collection and processing of the dataset, where we outline the data and showcase models to explore the research issue in alignment with the stated objectives.
Finally, we analyze estimation results and come to conclusion in order to answer presented hypotheses and research questions as stated above
Identification of research issue Literature review
Formation of regression model and methodology
Collecting data set Processing data set
Identifying sample country and sample period
Analysis data set Result discussion and interpretation
Conclusion and implication tot nghiep down load thyj uyi pl aluan van full moi nhat z z vbhtj mk gmail.com Luan van retey thac si cdeg jg hg
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