Is globalization detrimental to financial development? Further evidence from a very large emerging economy with significant orientation towards policies

ABSTRACT

This study attempts to explore the relationship between globalization and financial development by endogenizing economic growth, population density, inflation and institutional quality for India during the period from 1971–2013. Using the more conclusivecombined cointegration method, the study provides evidence of cointegration among these variables. The long-run and short-run estimates from the ARDL model and causality tests, respectively, suggest that globalization in its all forms (political, social and economic) and its overall measure as well as inflation are detrimental to financial development, while economic growth and population density both promote financial development. Furthermore, the results also point out that institutional quality is not conducive to financial development in India, and there exists a feedback effect between financial development and inflation. Moreover, financial development is influenced by economic growth, institutional quality and population density.

KEYWORDS:

• Globalization
• financial development
• institutional quality
• inflation
• India

JEL CLASSIFICATION:

• F41
• F36
• C22

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ It must be noted that globalization is unlikely to lead to financial development and economic growth on its own, in the absence of a stronger institutional reforms or quality in developing economies. Thus, globalization requires stronger institutional quality because this quality is crucial in promoting financial development and economic growth in developing countries (Rodrik 2007; Mishkin 2009). In this vein, the question that arises is: How to improve institutional quality? In this case, our reading of the theoretical elements of the institutional reforms proposed by Mishkin (2009) suggests that enhanced corporate governance, strengthened property rights, improved legal system, and successful deregulations of product and labour markets, enriched quality of financial information, minimal corruption, and improved regulation and supervision of the banking system are essential elements in building an institutional infrastructure that will eventually ensure a well-functioning financial system. Both Mishkin (2006) and Rodrik (2007) have a more extensive discussion of the elements of the financial infrastructure as well as references to that literature.

² See Bodenhorn and Cuberes (2010)

³ We used deflated inflation to convert the series of ‘domestic credit to private sector’ into real terms.

⁴ Updated data on all the measures of globalization is available at http://globalization.kof.ethz.ch

⁵ However, those tests provide ambiguous results due to their low explanatory power. They do not accommodate information about unknown dates of structural break stemming from the series, which further weakens the stationarity hypothesis. To resolve this issue, we have applied the Zivot–Andrews (ZA) unit root test which considers the presence of a single unknown structural break in the series. The results of the Zivot–Andrews structural break test are presented in Table 3. We find that all the variables have a unit root problem in the level in the presence of structural breaks. The structural breaks are found for the periods 1990, 1993, 1994, 1992 and 1991 (1988, 1989, 1991) in the series of financial development, economic growth, population density, inflation, institutional quality and globalization (economic globalization, political globalization and social globalization), respectively. We also note that all the variables are stationary in their first differenced form. This indicates that all the series are integrated of I(1). The results are available upon request from authors.

⁶ We have applied five tests for the lag order selection and robustness. These tests are the sequential modified LR test (each test is conducted at the 5% level), the final prediction error, the Akaike information criterion (AIC), the Schwarz information criterion (SIC) and the Hannan–Quinn information criterion. Each test suggests using an optimal lag of 2 for the empirical estimation. The results are not reported but would be available upon request from the authors.

⁷ The reason for using the Narayan (2005) bounds testing critical values over the critical values of Pesaran, Shin, and Smith (2001) is that the former values produce parsimonious results in small sample sizes. Therefore, the Narayan (2005) critical values are suitable for our analysis because our analysis has a small sample size.

⁸ Structural breaks are based on ZA unit root test.

⁹ The impact of economic globalization on financial development is negative but statistically insignificant

¹⁰ The results are available upon request from authors.

¹¹ The lag length used in the causality analysis is based on AIC as shown in Table 3.