Do financial inclusion and R&D matter? Exploring the effect of uncertainty on economic performance

ABSTRACT

Using a dataset that includes 24 developing and developed countries for the period 1984–2017, this research adopts outstanding deposits with commercial banks to GDP ratio and research and development (R&D) expenditure to GDP ratio as main proxies of financial inclusion and R&D, respectively. The empirical results suggest that promoting financial inclusion or R&D can offset the harmful effects of uncertainty on economic performance and that the impact of R&D with uncertainty is statistically significantly greater than the impact of financial inclusion with uncertainty. Moreover, our subsample analyses indicate that the mitigating effects of financial inclusion and R&D exist in nonfinancial crisis periods, developed countries, and the European region. To address endogeneity concerns, we employ six instrumental variables in a two-stage least squares regression (IV-2SLS). Our findings have useful policy implications to government for dealing with economic policy uncertainty for the economy’s benefit.

KEYWORDS:

• Financial inclusion
• R&D
• economic policy uncertainty
• economic performance
• IV-2SLS

Acknowledgments

We would like to thank Editor and the Referee for their highly constructive comments. The usual disclaimer applies, and the views are the sole responsibility of the authors.

Disclosure statement

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

Notes

¹ Bernanke, Gertler, and Gilchrist (1999), Christiano, Motto, and Rostagno (2014) and Gilchrist, Sim, and Zakrajšek (2014) find that the risk of corporate default and borrowing costs increase when volatility increases and higher borrowing costs reduce the investment and actual output of a company. Basu and Bundick (2017) indicate that higher volatility reduces consumer demand, output, capital return, and investment.

² Karaman and Yıldırım-Karaman (2019) investigate the relation between financial development and uncertainty and they find financial development could offset the negative impact of uncertainty on the growth. Our paper is different with theirs, and we use EPU to be the proxy of uncertainty and mainly investigate the function of financial inclusion rather than financial development.

³ As to instrumental variables, we provide detailed description in Section 3.1 and Appendix A.

⁴ We add control variables each by each because of high correlation among them.

⁵ According to Peia and Romelli (2020) and Maskus, Milani, and Neumann (2019), they find financial development could improve the R&D spending of firm and industry. However, when the big recession comes, the bank system would tighten the credit supply. Therefore, government should devote in R&D expenditures during recession, it would have a more directly positive influence on economic growth.

⁶ Baker, Bloom, and Davis (2016) proposes a new index to measure the policy uncertainty. They build several index components based on several indicators, including the frequency of newspaper references to policy uncertainty and then aggregate over the components to obtain this index.

⁷ However, R&D investment is viewed as an irreversible capital because a large proportion of R&D spending cannot be taken back if investment project fails. According to real options investment theory, firms would avoid huge losses by waiting for new information about market conditions when market uncertainty is high. This would decrease R&D investment. Based on this line, Bloom (2007) and Czarnitzki and Toole (2011) indeed show that R&D investment decreases in response to higher levels of uncertainty.

⁸ A higher value of the EPU index means a higher degree of uncertainty. Moreover, we divided the EPU index by 100.

⁹ Moreover, we also present descriptive statistics for our main variables, economic performance, EPU index, R&D, and FI1, by countries and by developed and developing countries in Appendix C. This table could allow us to compare the average values of these variables for each country more distinctly. From Appendix C, we find that the mean and the median values of R&D and FI1 in developed countries are significantly greater than that in developing countries. This implies that the government in developed countries may devote more resources in R&D and the degrees of financial inclusion are more well development in developed countries. For economic performance and EPU index, the results also indicate the mean and the median values of them are significantly different between developed countries and developing countries.

¹⁰ De Gregorio and Guidotti (1995) find significant negative correlation between financial intermediation and economic growth in Latin America; Ram (1999) exhibits negative association between financial development and growth; Shen and Lee (2006) indicate that financial development and growth perform nonlinear form.

Additional information

Funding

This work was supported by the Ministry of Science and Technology (MOST) of Taiwan to National Central University [MOST 110-2410-H-008-015-MY3]. Lee acknowledges the financial support from the Research Center of Scientific Finance and Entrepreneurial Finance of Ministry of Education of Sichuan Province (KJJR2021-001 and KJJR2021-011).