Abstract
This paper investigates the impact of financial development on economic growth in Pakistan using the Markov Switching Model over the period 1980–2017. The results based on two-state Markov switching model confirm the Schumpeter’s view that finance spurs growth. The result reveals that financial development augments economic growth in both high and low economic growth regimes in Pakistan. However, the impact of financial development on economic growth is found to be relatively higher in the high-growth regime. This implies that economic growth responds differently to financial development in low-growth and high-growth regimes. Among the control variables, trade openness and government expenditures impact economic growth positively, while labour force exerts a negative impact on economic growth.
Highlights
The relationship between financial development and economic growth is a much-debated issue in the empirical literature
Conclusion and policy implications This study investigates the regime-specific relationship between financial development and economic growth for the period 1980–2017
The results support the presence of a non-linear relationship between financial development and economic growth in Pakistan
Summary
The relationship between financial development and economic growth is a much-debated issue in the empirical literature. A large volume of empirical literature concluded that financial development spurs economic growth (Beck & Levine, 2004; Jalil & Ma, 2008; Khan, Qayyum, & Sheikh, 2005; Khan & Senhadji, 2000; King & Levine, 1993; Levine, 1997, 2005; Rajan & Zingales, 1998). The endogenous growth theorists argued that financial development helps to improve the efficiency of capital allocation, improve management of liquidity risks, efficiently diversify investor’s portfolios and enhance the efficacy of investment projects These factors can increase capital productivity, which exerting a positive impact on economic growth (Bencivenga & Smith, 1991; Greenwood & Jovanovic, 1990; King & Levine, 1993; Levine, 1991; Saint-Paul, 1992). Schularick and Taylor (2012) and Mian and Sufi (2014) maintained that, without proper rules and regulations, finance can become a powerful force for planting the seeds of future crises with adverse implications for economic growth and social welfare
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