Urbanization and growth nexus: do international financial flows matter?

Abstract

PurposeThis study examines the impact of urbanization on growth and the role of international financial flows in the urbanization-growth nexus.Design/methodology/approachThe study applies the panel least square estimation to examine the impact of urbanization on growth using panel data from 50 developing countries from 1980 to 2016. Further, addressing the endogeneity issues in panel estimations, the study applies the dynamic System-GMM approach to investigate the role of financial flows in urbanization and their impact on economic growth in developing countries.FindingsContrary to the conventional literature, we found a non-linear (U-shaped) relationship between urbanization and growth. Our findings demonstrate that growth is reduced at a lower level of urbanization due to less availability, concentration, and synchronization of production factors. The concentration of physical and human capital and technological advancement in urban areas help developing countries achieve economic growth at a higher level of urbanization. Robust estimations divulged that foreign aid spent on infrastructure development and expanding urban regions helps promote economic growth. Nevertheless, as a resilient factor, remittances buffer the rapid pace of urbanization and reduce growth by resisting the migration of labor and capital from rural to urban areas.Practical implicationsThe paper's findings suggest policymakers promote urban infrastructure and development using local and international funds since its increased level spurs economic growth. Further, the results advise policymakers to reduce aid dependency, attract FDI, and facilitate the easy and low-cost transfer of money to promote remittance inflows since both FDI and remittances positively contribute to economic growth.Originality/valueThe paper contributes significantly to the literature by determining the U-shaped relationship between urbanization and growth and highlighting the role of international flows in the urbanization-growth nexus.