The Nexus between Financial and Investment developments and State Capacity. The case of G-20

Abstract

On this paper we examine the relationships between state capacity, approximated by the Composite Index of National Capabilities, and certain macroeconomic and financial variables. Particularly, we study the nexus of their interactions by focusing on the G-20 economies from 1980 to 2020 by applying a robust GMM panel VAR model. Our results capture a negative and lasting impact of ‘domestic credit to private sector’, a negative short-term impact of market capitalization, along with a positive impact of inward and outward FDIs, and of gross capital formation, on state capacity. State capacity, in its turn, enhances in the short-term market capitalization, consumes credit to private sector, and substantially boosts gross capital formation in the medium-term. Trade openness enhances state capacity and is enhanced by state capacity as well. The presence of financial crises, such as the Asian Financial Crisis or the Global Financial Crisis, affects negatively state capacity. Conversely, the absence of financial crises has a positive impact on state capacity, leading to its amelioration. Furthermore, the specific case of the Second Oil Crisis is found to strengthen state capacity. These findings shed light to the mechanisms that impact national power and provide a framework for policy design and conduct.