Does Financial Development Cause Economic Growth? A Panel Data Dynamic Analysis for the Asian Developing Countries

Abstract

This paper examines the causal relationship between financial development and economic growth of the Asian developing countries from a panel data perspective and uses the system GMM technique developed by Arellano & Bover (1995) and Blundell & Bond (1998) and conducts causality testing analysis. The panel data sets involve 13 Asian developing countries: Bangladesh, India, Indonesia, South Korea, Lao PDR, Malaysia, Myanmar, Nepal, Pakistan, Philippine, Singapore, Sri Lanka and Thailand for the period 1990–1998. The result of our study is in agreement with other causality studies by Calderon & Liu (2003), Fase & Abma (2003), and Christopoulos & Tsionas (2004) that financial development promotes growth, thus supporting the old Schumpeterian hypothesis and Patrick's ‘supply-leading’ hypothesis.

Key Words:

• Finance-growth nexus
• demand-following
• supply-leading
• Asian countries

JEL CLASSIFICATIONS:

• O11
• O16
• O53

Acknowledgment

We thank the editor of this journal and an anonymous referee for helpful comments and suggestions on the earlier draft of the paper. All remaining errors are sole responsibility of the authors.

Notes

1. See Habibullah (1999b) for further discussion and description on financial liberalization in ten Asian developing countries.

2. The Association of South East Asian Nations (ASEAN) was founded in 1967 with the signing of the ASEAN Declaration. At the time of writing, the ASEAN member countries included Brunei, Cambodia, Indonesia, Lao PDR, Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam.

3. Shaw (1973) defines financial deepening as the phenomenon in which the financial sector grows at a rate faster than the real sector of an economy. On the other hand, the process of monetization refers to the size as well as the composition of the stock of money (money supply) in an economy. Chandavarkar (1977) notes that the difference between monetization and financial intermediation is that the latter refers to the process of mediation through institutions and instruments between primary savers and lenders and ultimate borrowers and is measured by the financial interrelations ratio. Thus, it connotes financial deepening rather than widening (enlargement of the money exchange economy), which is the phenomenon expressed in the term ‘monetization.’

4. In this study, Habibullah (1999a) has proposed the use of the divisia monetary aggregates as an alternative proxy for the financial development indicator. In general, the proposed divisia monetary aggregates do well in explaining the role of finance on economic growth in those Asian countries under study.

5. Arellano & Bond (1991) propose the two-step GMM estimator. In the first-step, the error terms are assumed to be independent and homoskedastic across countries and over time. In the second-step, the residuals obtained in the first-step are used to construct a consistent estimate of the variance–covariance matrix, then to relax the assumptions of independence and homoskedasticity.

6. All data were compiled from the various issues of the International Financial Statistics published by the International Monetary Fund.

7. If the residuals are not only serially uncorrelated but also homoskedastic, the first-step estimate is asymptotically equivalent to the two-step estimator.

8. Longer lag structures would reduce too much the time dimension of the data, and the resulting estimates would be unreliable as warned by Holtz-Eakin et al. (1988, 1989).