Does the financial system support economic growth in times of financialisation? Evidence for Portugal

ABSTRACT

This paper conducts a time series econometric analysis in order to examine empirically the relationship between the financial system and economic growth in Portugal from 1977 to 2016. The Portuguese financial system has experienced a strong wave of privatisations, liberalisations and deregulations since the adhesion of Portugal to the European Economic Community in 1986, which has not favoured a sustained path of strong economic growth since then. The paper estimates a linear growth model and a non-linear growth model, which includes four proxies for the financial system (money supply, credit, financial value added and stock market capitalisation) and four further control variables (inflation, government consumption, trade openness and education). The paper finds a negative linear relationship between the banking system and Portuguese economic growth, a positive linear relationship between the stock markets and Portuguese economic growth, a concave quadratic relationship between the banking system and Portuguese economic growth, and a convex quadratic relationship between the stock markets and Portuguese economic growth. This suggests that Portuguese policy makers should canalise efforts to decrease the importance of banking system and to increase the importance of stock markets in order to support more robust economic growth in the coming years.

KEYWORDS:

• Financial System
• economic growth
• Portugal
• time series
• autoregressive distributed lag estimator

JEL CLASSIFICATION:

• C32
• E44
• 016 and O47

Acknowledgements

The authors thank the helpful comments and suggestions of an anonymous referee, Sérgio Lagoa, Sofia Vale and the participants in Dinâmia’CET - Iscte Workshop on Dinâmicas Socioeconómicas e Territoriais Contemporâneas (Iscte - Instituto Universitário de Lisboa, January 2020). The usual disclaimer applies.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. The advantage of using the growth rate of the real per capita gross domestic product instead of the growth rate of the real gross domestic product as a proxy of economic growth is that this allows us to take into account not only the investors’ prospects, but also the people’s prosperity (Alexiou, Vogiazas, and Nellis 2018). Note also that the majority of the empirical studies on the relationship between the financial system and economic growth use the growth rate of the real per capita gross domestic product (Rioja and Valev 2004a, 2004b; Rousseau and Wachtel 2011; Hassan, Sanchez, and Yu 2011; Beck, Degryse, and Kneer 2014; Jedidia, Boujelbène, and Helali 2014; Breitenlechner, Gächter, and Sindermann 2015; Durusu-Ciftci., Ispir, and Yetkiner 2017; Ehigiamusoe and Lean 2018; Alexiou, Vogiazas, and Nellis 2018).

2. We recognise that some correlations seem to indicate the presence of multicollinearity, mainly because some of them are higher than the traditional ceiling of 0.8 in absolute figures (Studenmund 2005). Nevertheless, this hypothesis is rejected through the calculation of variance inflation factors, because they are lower than the traditional ceiling of 10 (Kutner et al. 2004). Results are available upon request.

3. For the majority of models, we put into consideration a number of lags between zero and four, as the unrestricted VAR does not satisfy the stability condition with a higher number of lags because at least one characteristic polynomial root would be outside the unit circle (Lütkepohl 1991). For the linear growth model with the proxy of credit and the non-linear growth model with the proxy of money supply, a number of lags between zero and three were put into consideration, and for the non-linear growth model with the proxy of credit, a number of lags between zero and two were considered in order to guarantee the aforementioned stability condition, which would not be fulfilled if we had used a higher number of lags.

4. Note that if we use two lags the hypothesis that the model is well specified in its functional form is also rejected. Results are available upon request.

5. Plots of the CUSUM tests are available upon request.