Low Levels Of Financial Development Research Articles

Finance–Growth Nexus: New Insights from the West African Region

ABSTRACTThis article examines the impact of financial development on economic growth in the West African region accounting for both structural breaks and cross-sectional dependency. Although the panel data study reveals that financial development has positive impact on economic growth in the entire West African region, the disaggregated data analysis discovers that variations in financial development can only explain variations in economic growth in about 75% of the countries in West Africa. This study has succeeded in revealing the countries where finance accelerates growth and countries where it does not. The weak impact of finance on growth in some of the countries could be due to low income level, low level of financial development, weak institutions, macroeconomic instability, and high inflation rates. Knowing where finance spurs growth and where it does not is fundamental for policymaking.

DOES FINANCE ALTER THE RELATION BETWEEN INEQUALITY AND GROWTH?

This paper introduces a model in which greater inequality reduces growth in economies with low levels of financial development but that this effect is attenuated in economies with more developed systems. The model also predicts that individuals in economies with developed financial markets have a higher tolerance to inequality. Using a panel dataset that covers a large number of countries, this paper shows empirical evidence that is consistent with the main predictions of the model. Overall, this paper's major findings highlight that some of the pernicious effects of inequality can be attenuated by improving access to credit. (JEL D3, E6, P1, O4, I2)

Entrepreneurship and human capital: The role of financial development

The previous literature is filled with mixed findings with regard to human capital's impact on entrepreneurial outcomes. Using data from Global Entrepreneurship Monitor, we re-explore the human capital-entrepreneurship relationship and attempt to clarify the mixed findings. In particular, the prior literature has treated human capital's impact on entrepreneurship in isolation, while in reality its impact depends on access to financial capital. Our results show that a rise in tertiary enrollment benefits entrepreneurship most when the level of financial development is low. For higher levels of financial development, the impact of tertiary enrollment on entrepreneurship is still positive but much lesser in magnitude compared to countries with lower level of financial development.

Two-stage DEA-Truncated Regression: Application in banking efficiency and financial development

This study evaluates the efficiency of peripheral European domestic banks and examines the effects of bank-risk determinants on their performance over 2007–2014. Data Envelopment Analysis is utilised on a Malmquist Productivity Index in order to calculate the bank efficiency scores. Next, a Double Bootstrapped Truncated Regression is applied to obtain bias-corrected scores and examine whether changes in the financial conditions affect differently banks’ efficiency levels. The analysis accounts for the sovereign debt crisis period and for different levels of financial development in the countries under study. Such an application in the respective European banking setting is unique. The proposed method also copes with common misspecification problems observed in regression models based on efficiency scores. The results have important policy implications for the Euro area, as they indicate the existence of a periphery efficiency meta-frontier. Liquidity and credit risk are found to negatively affect banks productivity, whereas capital and profit risk have a positive impact on their performance. The crisis period is found to augment these effects, while bank-risk variables affect more banks' efficiency when lower levels of financial development are observed.

Finance-Growth Nexus: New Insights from West African Region

This paper examines the impact of financial development on economic growth in West African region accounting for both structural breaks and cross-sectional dependency. Although the panel data study reveals that financial development has positive impact on economic growth in the entire West African region, the disaggregated data analysis discovers that variations in financial development can only explain variations in economic growth in about 75% of the countries in West Africa. This study has succeeded in revealing the countries where finance accelerates growth and countries where it does not. The weak impact of finance on growth in some of the countries could be due to low income level, low level of financial development, weak institutions, macroeconomic instability and high inflation rates. Knowing where finance spurs growth and where it does not, is fundamental for policy making.

Children as risky investment

ABSTRACTThis article provides a theoretical model to explain endogenous fertility and use the panel data of 169 countries to analyze the extent to which fertility behaviors are influenced by financial development and social security tax. A negative effect of financial development on fertility supports the evidence that people in countries with lower levels of financial development tend to have more children. Those people in countries, where there is limited access to other risky investments, tend to have more children. In addition, those who are poor are more likely to have more children, which will lower their overall welfare, and further reduce their investment in capital markets. Social security tax also has a negative impact on fertility behaviors.

Financial development and long-run volatility trends

Countries with more developed financial markets tend to have significantly lower aggregate volatility. This relationship is also highly non-linear—starting from a low level of financial development the reduction in aggregate volatility is far more significant with respect to financial deepening than when the financial market is more developed. We build a fully-fledged heterogeneous-agent model with an endogenous financial market of private credit and debt to rationalize these stylized facts. We show how financial development that promotes better credit allocations under more relaxed borrowing constraints can reduce the impact of non-financial shocks (such as TFP shocks, government spending shocks, preference shocks) on aggregate output and investment, and why this volatility-reducing effect diminishes with continuing financial liberalizations. Our simple model also sheds light on a number of other important issues, such as the “Great Moderation” and the simultaneously rising trends of dispersions in sales growth and stock returns for publicly traded firms.

Financial Development, Credit, and Business Cycles

How does financial development affect the magnitude of the business cycles fluctuations? We examine this question in a general equilibrium model with heterogeneous agents and endogenous credit constraints based on Kiyotaki (1998). We show that there is a hump-shaped relationship between the degree of financial frictions and the amplification of unexpected productivity shocks. This nonmonotonic relation is due to the fall in financial frictions having two opposite effects on the response of output. One effect is the reallocation of productive inputs between agent types, which, while active, increases with the fall in financial frictions. The other effect is the change in the demand of inputs, which decreases with the fall in financial frictions. At low levels of financial development, the reallocation effect dominates and a fall in financial frictions increases the amplification of productivity shocks. In contrast, at higher levels of financial development, a fall in financial frictions decreases the shock amplification because the reallocation effect disappears while the effect on the demand of inputs is still present.

Uncertainty, capital flows, and maturity mismatch

This paper explores a how the financial uncertainty generated by volatile international capital flows interacts with maturity mismatch on the balance sheets of nonfinancial firms to increase the volatility of output, investment, and total factor productivity (TFP) in emerging market economies. I build a model of a small open economy in which financial frictions force firms to fund long-term projects with short-term debt. In response to changes in the level of uncertainty regarding the availability of foreign borrowing, firms adjust their long-term investment, contributing to the volatility of investment and output as well as generating endogenous fluctuations in aggregate productivity. Using data from a panel of major emerging markets, I show that the volatility of portfolio debt flows negatively affects output by dampening investment, while the volatility of equity flows, which do not generate maturity mismatch, has no effect. Consistent with the mechanism in the model, the negative impact of capital flow volatility is larger at low levels of financial development and in industries with longer time-to-build lags. My estimates imply that shocks to capital flow volatility account for one fifth of the excess output volatility of the emerging markets in my sample relative to a set of small open advanced economies.

The Role of Foreign Banks in Trade

This paper provides evidence that foreign banks play an important role in facilitating international trade. Combining data on bilateral, sectoral trade with bilateral data on foreign bank presence for 95 exporting and 122 importing countries for the period 1995-2007, we show that exports are higher in sectors more dependent on external finance when foreign bank presence is greater, controlling for the impact of general financial development. In addition, we show that the entry of a bank from an importing country increases bilateral exports disproportionately more in external finance dependent sectors, both at the intensive and extensive margin. Furthermore, we find that the entry of a foreign bank from an importing country that has many globally active banks has a large impact in countries with relative low levels of financial development, suggesting that the (transfer of) specialized knowledge and technology is important. Our findings are consistent with globally active foreign banks facilitating trade over and beyond what domestic banks can do through both providing additional external financing and help overcome contracting and information problems and suggest that foreign banks have important benefits for the real economy.

Financial Resource Curse in Resource-Rich Countries

Why do commodity-dependent developing countries have typically lower levels of financial development than their peers? The literature has proposed many possible explanations, but it typically does not dwell on the deep mechanisms that drive such an outcome. In this paper, we argue that the main cause is the shocks in commodity prices. We test the hypothesis on 68 commodity-rich developing countries between 1980 and 2014, and we find strong evidence of the financial development resource curse through the channel of commodity price shocks, after controlling for other explanations found in the literature. The findings are robust to the different types of commodities, the nature of the shocks, and various indicators of financial development. We also show how the impact of these shocks can be mitigated through good quality of governance.

Does access to capital affect cost stickiness? Evidence from China

We study the effect of limited access to capital on firm cost stickiness, using data from a large sample of Chinese private firms over 1998–2007. Our results show that on average SG&A costs are anti-sticky. For firms in regions with lower levels of financial development, SG&A costs have lower sensitivity to sales increases and exhibit lower stickiness. Overall our findings suggest access to capital as an important determinant of cost stickiness.

Financial structure and economic performance in selected African countries: time series evidence

In this paper, the authors investigate the long-debated question of whether or not a country’s financial structure matters for economic performance and, if so, how exactly it matters. The study uses the Johansen cointegration and vector error correction modelling framework within a country-specific setting to examine empirically the existence of a long-run equilibrium relationship between the financial structure of a country and per capita GDP and the causality thereof. The empirical assessment is based on evidence from selected African countries over the period 1971-2013, notably Egypt, Nigeria and South Africa. Firstly, cointegration test results reported in this paper show that there exists a strong relationship between the financial structure of Egypt and South Africa, and per capita GDP in these countries. However, such a relationship is weak in Nigeria, mainly attributable to its low level of financial development and the possibility of the natural resource curse emanating from the oil industry. Secondly, the evidence also strongly suggests that the nature of the relationship between the financial structure of Egypt and South Africa and per capita GDP is positive, albeit based on different measures of financial structure. In Egypt, financial structure is measured by the S-Size ratio, while, in South Africa, it is proxied by the S-Activity ratio. In Nigeria, there is no evidence suggesting that the country’s financial structure influences per capita GDP. Lastly, coefficients of the error correction term for all three countries are low, suggesting inefficiencies in the financial system and possible rigidities within the economies

Volatility transmission in African foreign exchange markets

Purpose – The concept of volatility transmission and co-movement has witnessed a resurgence in the international finance literature in recent years after the black swan events which gave evidence of financial market linkages. The purpose of this paper is to examine the dynamic sources of volatility transmission in the foreign exchange market in recent financial market integration in Africa. Design/methodology/approach – A conceptual framework was adapted from the extant literature and was used as the basis of modeling exchange rate volatility transmission. This paper adopts a quantitative research approach and opts for augmented DCC model to empirically unearth the sources of exchange rate volatility transmission. Findings – The key findings of the study are that, the African market is more prone to shock from outside than in the region. Macroeconomic news surprises influence volatility transmission and co-movements. Robust support is found for trade balance, interest rate and gross domestic product. These findings clearly demonstrate the low level of financial development and challenges that sometimes exist in exchange rate-policy implementation by policy makers. Research limitations/implications – Interested academics and practitioners working in the area might incorporate bilateral investment into the model of exchange rate correlation in future research. Originality/value – Unilaterally considering exchange rate volatility transmission and subsequent augmentation of the DCC model, this study makes a modest contribution to the examination of exchange rate correlations in Africa. This study makes an important contribution in not only addressing this imbalance, but more importantly improving the relative literature on exchange rate volatility transmission.

Finance-growth nexus: Insights from an application of threshold regression model to Malaysia's dual financial system

The purpose of this paper is to test the growing converging views regarding the destabilizing and growth-halting impact of interest-based debt financial system. The views are as advocated by the followers of Keynes and Hyman Minsky and those of Islam. Islam discourages interest rate based debt financing as it considers it not very conducive to productive activities and human solidarity. Likewise, since the onset of the crisis of 2007/2008, calls by skeptics of mainstream capitalism have been renewed. The paper applies a threshold regression model to Malaysian data and finds that the relationship between growth and financial development is non-linear. A threshold is estimated, after which credit expansion negatively impacts GDP growth. While the post-threshold negative relationship is found to be statistically significant, the estimated positive relationship at lower levels of financial development is insignificant. The findings provide support to the above views and are hoped to guide monetary authorities to better growth-promoting policy-making.

On International Consumption Risk Sharing, Financial Integration and Financial Development

ABSTRACTThis article investigates the empirical link between international consumption risk sharing, financial integration, and financial development for a group of twenty-nine developed and developing countries in the G7, the Euro area, and the OECD. Estimation results indicate that (1) risk sharing in the Euro area is higher than those in the G-7 and the OECD, and (2) a higher degree of risk sharing is associated with a greater degree of financial integration and a lower level of financial development. These results suggest that more financially integrated countries might be better able to insure themselves against idiosyncratic income shocks and countries with more developed financial markets might tend to engage in less consumption risk sharing with other countries thanks to their own sophisticated financial markets. Holding financial integration and financial development equal, countries in the Euro area engage in significantly more risk sharing than the ones in the G7 and the OECD.

Financial development, exchange rate regimes and productivity growth: Theory and evidence

This paper provides a microfounded, quantitative model that rationalizes recent empirical evidence by Aghion et al. (2009), who find that fixed exchange rate regimes lead to higher long-run productivity growth in countries with low financial development, while the effect in financially developed countries is insignificant. The channel that explains this evidence in my model is the following: A fixed exchange rate regime leads to lower inflation when the money growth is otherwise high under flexible exchange rates. In turn, lower inflation results in higher long-run productivity growth since financial intermediaries hold a fraction of deposits as reserves, whose return is lower than the market rate and, thus, is affected by inflation. I show that the positive effect of fixed exchange rate regime on growth is larger for countries with lower levels of financial development because inflation and the fraction of deposits held as reserves are typically higher in these countries.

Poverty Effects of Remittances: a Comparative Analysis

AbstractThis paper studies the impact of remittances on cross‐country poverty using a panel data set from 65 developing counties over a long period 1970–2008. This study differs from the existing literature on poverty impact of remittances by explicitly noting the importance of financial development in shaping the link. This analysis shows that the effect of remittances on poverty depends on the level of financial development of a remittances receiving economy. Those economies that have a low level of financial development seem to acquire an unfavourable effect of remittances while economies with comparatively developed financial systems do not suffer from the adverse effects of remittances. In sum, remittances accentuate not ameliorate poverty in countries with the low level of financial development. Copyright © 2014 John Wiley & Sons, Ltd.

Financial development and barriers to the cross-border diffusion of financial innovation

This paper explores the determinants of financial development by focusing on the role played by barriers to the diffusion of financial technology. These barriers are measured using human genetic distance from the technology frontier. The results based on cross-sectional data for 123 countries suggest that genetic distance to the global frontier has an economically and statistically significant effect on financial development, in that countries that are genetically far from the technology leader tend to have lower levels of financial development. Genetic distance is found to have the largest effect, even after controlling for other determinants of financial development established in the literature. These findings indicate that cultural barriers to the diffusion of financial technology across borders impact financial development by influencing the follower countries’ ability to adopt and adapt innovations from the frontier.

Financial Development and Long-Run Volatility Trends

Countries with more developed financial markets (as measured by the private debt-to-GDP ratio) tend to have significantly lower aggregate volatility. This relationship is also highly non-linear starting from a low level of financial development the reduction in aggregate volatility by financial deepening is far more significant than it is when the financial market is more developed. We build a fully-‡edged neoclassical growth model with an endogenous financial market of credit arrangements and private debt to rationalize these stylized facts. We show how financial development that promotes better credit allocations under more relaxed borrowing constraints can reduce the impact of non-financial shocks (such as TFP shocks, government spending shocks, preference shocks) on aggregate output and investment, and why this volatility-reducing effect diminishes with continuing financial development. Our simple model also sheds light on a number of other important issues, such as the Great Moderation and the simultaneously rising trends of dispersions in sales growth and stock returns for publicly traded firms.