Abstract
Most empirical analysis of the finance-growth nexus has used measures of financial development such as the ratio or monetary of financial assets to GDP to measure financial development. We argue that from a policy perspective measures of financial liberalisation or reform are of greater interest and, besides, are less likely to be beset by endogeneity problems which have dogged the empirical growth literature. We develop such a measure by combining the ‘Delphi’ method and principal components analysis to construct an index of financial liberalisation for China. Much of China’s financial development has been policy-driven and we could expect to find a distinct difference, at least in timing, between measures of financial reform and financial development. We compare our financial liberalisation index to a number of standard measures of financial development and find that there is pervasive evidence that financial liberalisation Granger-causes financial development but not vice versa.
Highlights
Empirical research on the determinants of economic growth has shown a resurgence over the past decade or so
The policy question has been important for the finance and growth strand of the literature since there has been a rapid development of the financial systems of a number of developing countries fuelled, partly at least, by government policy which has freed up financial systems previously subject to pervasive regulations
In this paper we have argued for the importance of the distinction between financial development and financial liberalisation
Summary
Empirical research on the determinants of economic growth has shown a resurgence over the past decade or so. Two early (and similar papers) by Li and Liu (2001) and Liu and Li (2001) examine the relationship between “financial liberalisation and growth in China’s economic reform” by regressing aggregate GDP growth on investment growth disaggregated into four components according to the source of funding, the argument being that the source of funding has changed with the development of the financial system so that it provides (indirect) evidence about the effect of such development on growth. It is likely that financial development measures are generally endogenous in an econometric sense making it difficult to interpret regression results in cause-and-effect terms, a problem that has dogged the empirical growth literature in general Neither of these disadvantages are likely to be as severe for measures of financial liberalisation which more closely reflect the policy changes driving the development of the financial system.
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