Technical Efficiency and Financial Deepening in the non‐OECD Economies

Abstract

This contribution investigates the channels through which the relationship between financial deepening and growth materializes. While this relationship has been extensively explored over the recent past, less attention has been paid to the channels through which the relationship comes about. In continuing our exploration of this relationship, instead of using a total factor productivity measure, as the existing literature does, we model productive efficiency in a more explicit and comprehensive way using non‐parametric methodologies to construct efficiency frontiers. We consider the link between financial deepening and productive efficiency in a number of non‐OECD countries, using the data available from the Penn World Tables. Our results show that financial development has in general a positive effect on productive efficiency.

Key Words:

• Financial deepening
• efficiency
• data envelopment analysis

JEL Classification:

• O4
• G1

Acknowledgement

We thank the participants to the Cambridge Conference on Understanding Economic Growth: New Directions in Theory and Policy, Downing College, 1–3 September 2005, for their comments. We are grateful to an anonymous referee for insightful comments and suggestions. The usual disclaimer applies.

Notes

1. Aghion et al. (2004) warn of the dangers of countries at an intermediate level of financial development when implementing financial liberalization policies, for full financial liberalization under these circumstances could lead to serious destabilization.

2. The channels discussed in the text are due to a number of contributors. In Arestis et al. (2005) a more detailed discussion of the channels referred to in the text is provided and others that are not strictly relevant to the discussion here.

3. For the case of constant returns to scale (CRS) the production possibility set, S, becomes

4. This is for example consistent with Stigler’s (1976) argument, which suggests that any observed input–output combination can be viewed as efficient and measured inefficiencies emerge because we fail to take into account relevant variables.

5. They are equivalent, however, when the technology is accompanied by constant returns to scale (Ray, 2004, p. 7).

6. M3 or LLY is the sum of currency and deposits in the central bank (M0), plus transferable deposits and electronic currency (M1), plus time and savings deposits, foreign currency transferable deposits, certificates of deposit, and securities repurchase agreements (M2), plus traveller’s cheques, foreign currency time deposits, commercial paper, and shares of mutual funds or market funds held by residents.

7. Detailed efficiency results for each country and each year are available upon request from the authors.

8. In an attempt to control for endogeneity and reverse effects, we consider a dynamic version of the basic specification with lagged credit to private sector as the financial depth variable. The results appeared consistent with those that consider contemporaneous data. Using changes in the variables rather than levels provided similar results. All these results are available from the authors upon request.