Effect of poverty on financial development: Does trade openness matter?

Abstract

Numerous studies in the literature have investigated the effect of financial development on poverty, and tend to report a poverty reduction effect of financial development. The present paper considers the issue the other way around, by examining the effect of poverty on financial development. In particular, it has investigated the financial development effect of poverty through the human capital channel. Additionally, it has examined whether the effect of poverty on financial development depends on countries' level of trade openness. The analysis is carried out using a sample of 136 countries (both developed and developing countries) over the period 1995–2017, and the two-step Generalized Methods of Moments (GMM). Results have shown that higher poverty rates undermine the development of the financial sector, and this effect works through the human capital development channel. In fact, higher poverty rates are associated with lower financial development in countries that accumulate less human capital. Furthermore, trade openness matters for the effect of poverty on financial development. Specially, higher poverty rates undermine the expansion of the financial sector in the context of lower levels of trade openness. Thus, greater trade openness helps to mitigate the negative financial development effect of poverty, and this negative effect may turn out to be positive for very high levels of trade openness.