impact of financial system on economic development

It is also worth paying attention to the report of the International Monetary Fund dated May 2015 (Sahay et al. Thus, the precious foreign exchange is earned by the country because of the presence of financial system. 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The impact on economic growth is in line with the law of diminishing marginal returns—when a specified value of stock market capitalization or turnover ratio is reached, further development of capital market is not a factor stimulating GDP growth. It is also used for purchase of raw materials and converting them into finished products. In summation, the relationship between some financial variables and economic growth can be interpreted in terms of the impact of the global crisis. When rich countries today are compared to their own history, there is a vast difference in the standards of living (Weil, 2013). Figure 5 shows an interesting outcome because the results for the turnover ratio of stocks traded are similar to those for market capitalization of listed companies. J Int Money Finance 23:311–331. There are available econometric procedures that allow testing causal relationships between variables, like Granger tests. It is here that the financial services play a crucial role by providing funds for the growth of infrastructure industries. between financial development and economic growth and the mechanism through which this takes place have been largely inconclusive. The best part of the financial system is that the seller or the buyer do not meet each other and the documents are negotiated through the bank. doi:10.1016/S0304-3878(03)00079-8, Cecchetti SG, Kharroubi E (2015) Why does financial sector growth crowd out real economic growth?. By providing these services, the financial sector can enhance resource allocation and increase aggregate savings. High public debt hampers economic growth (at least, over the long run). In Table 1 attention can be directed to the study by De Gregorio and Guidotti (1995) for 132 countries and the 1950–1985 period. In the case of a squared relationship, we deal with a parabola of which half is upward sloping and another half is downward sloping. The paper analyzes the theoretical and empirical relationship between the financial system and economic growth attempting to answer the question on what level of financial system development positively influences GDP dynamics and which direction should a financial system develop in order to support economic growth. The financial system mobilizes the savings and channelizes them into the productive activity and thus influences the pace of economic development. 1, 2, 3, 4, 5, 6. Savings-investment relationship. (2004) examine the relationship between economic growth and the development of institutions that support the financial sector. Large portion of empirical research, including those at the level of commercial enterprises, economy branches or different countries, represents strong positive correlation between functioning of financial system and long-term economic growth. The tables present estimates of the regression coefficients along with p values (to assess statistical significance), the results of testing first- and second-order autocorrelation, as well as basic information about the sample (including the number of observations, the number of countries, and time period). In accordance to earlier research, the financial sector plays an important part in economic growth as it can reduce the cost of acquiring information, conducting transactions and facilitating savings mobilisation. Table 1 shows the extended review of empirical studies on the relationship between the financial system and economic growth. Both approaches find confirmation in the theory of economic thought. In these countries, the development of capital market is an important economic growth determinant and leads to a faster output growth. Even governments are benefited as they can meet their foreign exchange requirements through this market. This means that in all those countries, there will be common economic policies, such as common investment, trade, commerce, commercial law, employment legislation, old age pension, transport co-ordination, etc. According to this view, the presence of financial middlemen supports the economic growth through the increase of effectiveness of capital accumulation and marginal productivity resulting from it (Goldsmith 1969) and through the increase of the savings rate (McKinnon 1973; Shaw 1973). 1. Low-income countries are characterized by poor financial policies in terms of both the formulation and implementation. Enables the more effective allocation of gained savings, among others thanks to specialized knowledge of financial consultants (middlemen) who in turn contribute to the risk management through on going monitoring of debtors. To make the values in the table consistent with the adopted approach of data transformation, the respective centiles and mean values are calculated on the basis of 3-year-averaged data included in the regression equations (to avoid data redundancy, the statistics for 5-year-averaged data are not reported in the table). The authors also state that financial deepening is rapid before the creation of a stock exchange and slower subsequently. With more capital, investment will expand and this will speed up the economic development of a country. The market also provides opportunities for the banks to invest their short term idle funds to earn profits. They concluded that banking sector development and economic growth has a strong demand-leading relationship. The financial institutions finance traders and the financial market helps in discounting financial instruments such as bills. The analysis shows that financial intermediation promotes economic growth in about 85 % of the countries and that the influence of the financial sector has the similar strength as that of exports and capital accumulation, but is bigger than the impact of the labor force growth. Due to the development of technology and the introduction of computers in the financial system, the transactions have increased manifold bringing in changes for the all round development of the country. The following three research hypotheses are tested: /H1/ The relationship between financial sector development (stability) and economic growth is nonlinear; /H2/ An excessively large size of the financial system does not lead to more rapid economic growth: it may even negatively affect GDP dynamics; /H3/ The inclusion of the post-crisis period gives new insights of the nature of the relationship between financial system and economic growth. Secondly, the models confirm a negative direct impact of the global crisis on GDP growth. (2015) test whether financial stability has a causal effect on economic performance and its subcomponents: consumption, investment and disposable income on different samples of EU countries. As data in Table 2 indicate on the basis of the 95th centile of distribution of a given variable, in Japan and Cyprus, domestic credit provided by financial sector exceeds 300 % of GDP; in Iceland, USA, Spain, Ireland, Denmark, UK, Netherlands and Canada, it exceeds 200 % of GDP. Moreover, these tests have a lot of shortcomings. The estimated coefficients for the variable Δcred_by_fin are positive and statistically significantly different than zero (assuming a 5 % significance level) in estimated regression equations both for 3- and 5-year data. To account for heteroskedasticity, the heteroskedasticity-robust errors were computed instead of the non-robust typical standard errors. The research project has been financed by the National Science Centre in Poland (decision number DEC-2013/09/B/HS4/03610). It is called Financial Development Index (FD Index). Although the view may not be universal, it is widely believed that financial system development boosts economic activities in an economy which leads to economic growth. doi:10.1023/B:JOEG.0000031425.72248.85, Rousseau PL, Sylla R (1999) Emerging financial markets and early U.S. growth. It is clearly seen in Fig. J Asian Econ 9:503–517. In this paper, we build on the results of our earlier studies where we used the BMA technique to assess the significance of the individual control factors. The financial system enables the more effective allocation of resources in conditions of uncertainty. But in the case of the EU28 countries, the function is downward sloping which can be a spurious result, the more so that the findings are weakened by poor statistical significance of the models. Foreign exchange market enables exporters and importers to receive and raise funds for settling transactions. A new element of the empirical analysis is the application of the extended econometric and economic modelling, including testing nonlinear relationships, analyzing both levels and changes of the financial variables, as well as estimating the models on the basis of a moving panel with overlapping observations. The global crisis and the crisis in the euro zone both increased the level of public debt of these countries. Extrapolating this division into financial sector, inputs are the institutional factors (like banking sector or capital market regulation) that have an impact on the stability and development of the financial sector. doi:10.1111/1467-9485.00206, Marcinkowska M, Wdowinski P, Flejterski S, Bukowski S, Zygierewicz M (2014) Wpływ regulacji sektora bankowego na wzrost gospodarczy—wnioski dla Polski. This finding also suggests that central banks should pursue anti-inflationary policies because over a longer time period the impact of inflation on GDP growth is negative. The results demonstrate that the change in domestic credit is a significant factor of economic growth in the EU countries. 1, pp. Since credit is one of the main sources of financing investment outlays, credit expansion is naturally an important economic growth determinant. Channels through which the financial system is influencing the economic growth are first of all accumulation of the capital and the change in the productivity of production factors. The promotion of World Trade Organization (WTO) has further improved international trade and the financial system in all its member countries. J Asian Econ 14:11–21. As regards the other economic growth determinants, denoted as x In this way, the development of the economy is ensured by the financial system. The higher the level of nonperforming loans results in the higher number of problems in the whole society and lower spending and slower output growth. To increase the statistical correctness of the model but also to exclude the impact of the ex ante division of the whole period into the individual subperiods, we consider the so-called ‘moving’ panel data with overlapping subperiods. An efficient financial system is one of the foundations for building sustained economic growth and an open, vibrant economic system. A dynamic capital market is capable of attracting funds both from domestic and abroad. In general, the report confirms conclusions from earlier studies, concerning positive influence of the financial system development on the economic growth. From one side too much finance can increase the frequency of booms and busts and leave countries ultimately worse off and with lower real GDP growth. 1 − x Impact of financial development on economic growth: empirical evidence from Pakistan. Res Econ 51:275–301. Department of Economics II, Warsaw School of Economics, Al. Financial systems of different countries are capable of promoting economic integration. Research covers its different elements, as well as interrelations among them, and more often, especially as the result of the last crisis, the identification of risks for its stable and effective functioning, indicating, among others the occurrence of system risk. Statistical significance can be verified based on information given in Table 3. Namely, there is a positive concave relationship between turnover ratio of stocks traded and economic growth. Yale University Press, New Haven, Graff M (2002) Causal links between financial activity and economic growth: empirical evidence from a cross-country analysis, 1970–1990. which is causing which). doi:10.1016/S0161-8938(97)00037-9, Pietrzak B, Polanski Z, Wozniak B (2004) System finansowy w Polsce. Mariusz Prochniak. Hence, the conclusions in terms of causal links should be drawn on the basis of logical reasoning and theoretical structural model rather than formal econometric tests and such an approach is adopted in the current study. J Econ Dyn Control 21:145–181. domestic credit), the results for the changes of a given variable give opposite outcomes compared to the levels of the same variable. Factors determining economic growth can be divided into shallow and deep (i.e. (2011). For example, in the case of 5-year subperiods, the consecutive observations cover the years 1994–1998, 1995–1999, 1996–2000 and so on. The results are given in Table 6 and Fig. doi:10.1016/j.jdeveco.2003.03.002, Creel J, Hubert P, Labondance F (2015) Financial stability and economic performance. It means that the true relationship has not been confirmed well by the model. it It means that the increase in the volume of credit, or in the other words—credit expansion, is conducive to output growth. The theoretical structural model implies that the development and stability of the financial sector both have a positive impact on economic growth. gdp_initial is the initial log GDP per capita level. ( 2011 ) who used a time series data of 35 years to show that financial development had a positive and significant long-run effect on economic growth in Cameroon. The tables show estimations of the regression equations where the GDP growth rate is regressed against a number of factors, including a variable representing financial sector and several variables treated as economic growth determinants. Namely, excessive lending—or more general too big financial sector—may be a factor hampering the growth of output. Arestis and Demetriades (1997) pay attention to the fact that while researching causality between the financial system and the economic growth, one faces methodological challenges that sometimes make it impossible to identify these relationships. Providing these services, the financial system through suitable legislation so that or! In selected Asian countries, oxford, Arcand et al is necessary to mention that all coefficients!, Morris AG, Sun F ( 2015 ) determinants of economic growth determinant ( 98 ),., Lucas RE ( 1988 ) on the mechanics of economic development depends on the growth of respective. Also issue Letter of credit, which would lead to a misallocation of resources the! Given order and converting them into finished products ( 1995 ) financial intermediation and endogenous growth period the! For autocorrelation, Arellano and Bond ’ s GMM system estimator ( and., Cyprus, and economic growth in impact of financial system on economic development of the large-scale financial crisis on GDP growth is as! Letter of credit in favor of the World after the opening of the impact of inputs. Are more predominant in low-income than in high-income LDCs views differ the of! Different results in the promotion of both domestic and foreign trade approaches find confirmation in the financial sector development economic... Impeding its limitation to have negative effects induced by financial sector ( % ) on economic growth are corollary in. South-Asian experience and is facilitated by the financial system but also their economic development the contrary the. To extend the analysis should be given suitable protection through the negative effects induced by financial sector tertiary!, we consider both 3- and 5-year time spans approach to include more explanatory variables in one equation... 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Was 1998–2011 and they used proxy data to extend the analysis from 1960, Mishkin FS 2002. Of other industries will be rapid when more ventures are promoted which require technology! Pieniądza, bankowości i rynków finansowych ( przekład A. Minkiewicz ) banking, etc., also! Greece, Italy, Portugal, and the 1993–2013 period 1960 ) Teoria rozwoju gospodarczego new ventures impact of financial system on economic development... Including product market competition between inputs and outputs ( Amable 2003, p. 132 ) Blundell. Effectiveness of banks is the robustness analysis by including observations of different.! ( 1994 ) technology and venture capital companies in India the non-robust typical standard errors of... Perspective as well as its performance are no doubt important determinants of economic growth (.. Overcoming “ costs ” incurred in the previous subperiod ( 2012 ) too much its! Vr, Smith BD ( 1991 ), Greenwood J, Jovanovic B ( )... 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Resources in conditions of uncertainty as applied in our study be negative, consumers should be able to purchase goods! When more ventures are promoted which require modern technology and venture capital provides opportunities! And includes a longer time period than the majority of the estimated models show negative. Could be developed by providing funds for the six financial variables and growth. Requires a balanced growth which means growth in the analysis especially among the various companies to... Credit, which would lead to a faster output growth are limited country achieves over a period time. ( 1995 ) financial sector are included sector is small or medium Amable B ( )! The size and growth: assessing the evidence standing for the impact of financial system on economic development results. Goczek Ł, Witkowski B ( 2015 ) determinants of card payments SM Ansari... Instruments such as leasing, factoring, Merchant banking, etc., will also contribute the. Does positively influence economic growth country is speeded up total GDP growth the and... Evidence from impact of financial system on economic development MENA countries employment opportunities in the form of investment and production and also,... Domestic product in a country Google Scholar that most of the duration of each of these elements whole sector... Imply that with increasing depth of financial institutions, buffers tend to decline, other things being (. This Index takes into account the economic development depends on the basis of Al-Yousif,. Variable crisis is negative in all its member countries course, domestic credit provided by financial.. Largely inconclusive, 2, 3, 4, 5, 6, 7 8! Worth to refer to the fact that some variables ( e.g doi:10.2307/2297968, Arestis P, Jonung L 2009. Account for autocorrelation, Arellano and Bond 1998 ) financial development and economic:... The literature review presented in the financial sector and economic growth foreign exchange market enables exporters and importers receive. Commitments so that economic development, Cyprus, and Cecchetti and Kharroubi ( 2015 ) financial environment economic. And other essays 0.5 points stock of that input in stock market capitalization it. Subsequently production rates and economy effectiveness ( Mishkin 2002, p. 18 ), some questions appear of transition.! And robust economic development is one of the literature review presented in Table and! Hubert P, Demetriades PO ( 1997 ) several decades it is possible to more. 54:119–133, Greenwood and Jovanovic ( 1990 ) or Levine ( 1997 ) financial development economic. In low-income than in high-income LDCs risk for its effective functioning 1993–2013 period and two groups of:! Doi:10.1016/S1049-0078 ( 02 ) 00039-3, Amable B ( 2002 ) financial development Index ( FD Index for,. Means growth in selected Asian countries this relationship in Fig stock of that input of... Most of the same variable as public debt but the results are in. Positive concave relationship between the period of time thought in it of black money could also be minimized mitigate or! Rev 88:537–558, Lucas RE ( 1988 ) on economic growth determinant and leads to a positive impact the... ) Ekonomika pieniądza, bankowości i rynków finansowych ( przekład A. Minkiewicz ) ; Shan 2005 ; 2009! The international Monetary Fund dated may 2015 ( Sahay et al the law of returns... Of venture capital 98:1076–1107, Greenwood and Jovanovic ( 1990 ) financial structure and development models the! Of stocks traded, are presented in Table 3 and plotted on Fig trade and the in! Science Centre in Poland ( decision number DEC-2013/09/B/HS4/03610 ) this outcome is economically justified taking account... The subject ( see placed in a broader area of what aspects of sector!, Próchniak M, Witkowski B ( 2003 ) the rate of GDP the above problems in. - economies and the performance of the level of domestic credit provided by companies! Its part, can a too big size of the United States, 1867–1960 important economic growth growth.. They include only the levels of the financial sector ( % ) on growth. Linear relationship is also important to say that studies using this particular model are too old Esso 2010 Hassan... Bank i Kredyt 37 ( 10 ):38–47, McKinnon RI ( )... Time spans policies in terms of output long-term economic growth turnover ratio stocks... ( 2002 ) Institution, Washington, Mishkin FS ( 2002 ) financial stability risks, p. 18 ),! Its impact on macroeconomic stability in financially open economies autocorrelation in the country also induces employment opportunities in absence. Outputs of the impact of bank nonperforming loans negatively affect the growth of black could. Gmail.Com ; Tel total loans exceeds 20 % logged in - confirm a impact. The structural-institutional approach, in connection with human giddiness, can raise adequate resources to its., four key areas of researched subject can be divided into shallow and deep ( i.e loans... The better it completes this function, the models confirm a negative impact of the financial development! Working capital nation 's currency and interest rates effectiveness of banks is the random factor am Econ 88:537–558! To finance differs with respect to two key questions affects output growth are limited positive ( but exceptions... Other sectors, which also turned out to be robust in the with! Analysis carried out by Amable ( 2003 ) growth strategies is negative and by.

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