Abstract
Institution has been investigated having indirect role on economic growth. This paper aims to evaluate whether the quality of institution matters for economic growth. By applying institution as instrumental variable at Foreign Direct Investment (FDI), quality of institution significantly influence economic growth. This study applies two set of data period, namely 1985-2013 and 2000-2013, available online in the World Bank (WB). The first data set, 1985-2013 is used to estimate the role of financial sector on economic growth, focuses on 67 countries. The second data set, 2000-2013 determine the role of institution on financial sector and economic growth by applying 2SLS estimation method. We define institutional variables as set of indicators: Control of Corruption, Political Stability and Absence of Violence, and Voice and Accountability provide declining impact of FDI to economic growth.
Highlights
The correlation between financial sector development and economic growth has drawn attention economists since Joseph AloisSchumpeter in 1911 argued that financial sector plays an important role in increasing productivity and economy of a country
Schumpeter argued that the financial sector play a role in the development of technological innovation and economic growth resulted from basic services provided by the financial sector such as mobilizing savings, evaluating investment, managing risk and facilitating transactions
The results of empirical study indicate that the correlation between financial sector development and economic growth has high heterogeneity between countries, regions, financial factors, and causality (Eschenbach, 2004)
Summary
Schumpeter in 1911 argued that financial sector plays an important role in increasing productivity and economy of a country. Schumpeter argued that the financial sector play a role in the development of technological innovation and economic growth resulted from basic services provided by the financial sector such as mobilizing savings, evaluating investment, managing risk and facilitating transactions. This concept was later corroborated by the results of several researches (Arestis and Demetriades, 1997; Samargandi et al, 2013). Lucas (1988) found that the role of financial sector in economic growth of a country is very small and is not an important factor. The aforementioned debate shows that financial sector play a role in economic growth, but the size of the role greatly depends on macro-economic, socio-economic, and institutional conditions of a country
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