Do Finance and Trade Foster Economic Growth in the New EU Member States: Granger Panel Bootstrap Causality Approach

ABSTRACT

The aim of this paper is to investigate whether financial development and trade openness enhance economic growth in 11 new EU member states. While the overwhelming studies employ a simple measure of finance (credit to GDP ratio or stock market capitalization), we run growth regressions using a new IMF broad-based measure, which covers three dimensions of financial development: depth, access, and efficiency. We use a bootstrap panel-data approach based on seemingly unrelated regression (SUR) systems, which takes into account cross-sectional dependency and slope heterogeneity among countries. Such an approach gives separate regression coefficients for each country. The main findings are as follows: (1) the statistically significant unidirectional Granger causality from finance to economic growth is evidenced in five countries under examination (Bulgaria, Lithuania, Poland, Romania, and Slovenia); (2) trade openness is statistically significant Granger-cause of growth in six new EU member states (Croatia, Latvia, Lithuania, Romania, Slovakia, and Slovenia); (3) the reverse causalities, i.e. running from growth to finance were found in two countries (Hungary and Slovenia), and from growth to trade openness in Croatia. The policy-oriented recommendation is that new EU member states from Central and Eastern Europe may gain pro-growth benefits from further finance and trade development, however, the policy-makers should be aware of possible nonlinearities and conditionality of these relationships.

KEYWORDS:

• Financial development
• trade openness
• finance-growth and trade-growth nexus
• Granger panel bootstrap causality analysis

JEL Classification:

• F40
• F43
• O16
• O43
• C33
• C53

Disclosure statement

No potential conflict of interest was reported by the authors.

Correction Statement

This article has been republished with minor changes. These changes do not impact the academic content of the article.

Notes

1. A complex explanation of how finance affects long-term economic growth was delivered by King and Levine (1993), Beck, Levine, and Loayza (2000), Levine (2005), Rousseau and Wachtel (2011) and Beck (2012). Direct pro-growth effects of trade openness were identified, for example, by Busse and Kröniger (2012) and Chang, Kaltani, and Loayza (2009). Many other authors, like Grossman and Helpman (1991) or Frankel and Romer (1999), identified channels through which trade influences the rate of growth.

2. There is wide evidence which documents a meaningful rise of protectionism after 2009. Databases reporting traditional sources of trade policy measures, like WTO, as well as relatively new initiatives, for example, Global Trade Alert, confirm a prevalence of non-tariff instruments, including direct state aid, guarantees and bailouts which were commonly implemented in the aftermath of the global financial crisis. The terms “behind-the-border measures” or “murky protectionism“ reflect the essence of the contemporary discriminating instruments (Baldwin and Evenett 2009; Evenett 2019).

3. The new EU member states seem to be susceptible to such spill-over effects due to their close trade and financial ties with other EU countries, relatively small size and high openness of their economies. The evidence for the vulnerability of CEE countries to shock transmission can be found, for example, in OECD (2012) and Deltuvaitė (2017).

4. According to Arcand, Berkes, and Panizza (2015), the marginal effect of financial development on output growth becomes negative when credit to the private sector surpasses 110% of GDP. Probably, there is no one point of “too much finance” that holds for all countries at all times, and it depends on country’s characteristics including income level, institutions, and regulatory and supervisory quality (IMF 2015).

5. Rodriguez and Rodrik (2001) analyzed four most cited papers concerned with cross-national statistical evidence on trade and growth, which all claimed to find a positive association between economic integration and growth or convergence. These were Dollar (1992), Sachs and Warner (1995), Ben-David (1993), and Edwards (1998).

6. Pesaran (2004) shows that the CD test has a mean of zero for fixed T and N and is robust to heterogeneous dynamic models including multiple breaks in slope coefficients and/or error variances, so as long as the unconditional means of the dependent and independent variables are time-invariant and their innovations have symmetric distributions. However, the CD test will lack power in certain situations where the population average pair-wise correlations are zero, but the underlying individual population pair-wise correlations are non-zero (Pesaran, Ullah, and Yamagata 2008).

7. This is important because using the levels of the variables directly in the empirical analysis may play a crucial role in determining causal linkages since differencing variables to make them stationary may lead to a loss in the trend dynamics of the series (Clarke and Mirza 2006).

8. $p_i$ (for $i=1,\dots 3$) in formula (11) denotes number of lags.

9. These sets of equations described in the Eq. (11)(11) $\begin{array}{rl}& Y_{1t}={\alpha }_{11}+\sum _{l=1}^{p_1}{\beta }_{11l}{Y}_{1t-l}+\sum _{l=1}^{p_2}{\delta }_{11l}{X}_{1t-l}+\sum _{l=1}^{p_3}{\phi }_{11l}{Z}_{1t-l}+{\epsilon }_{11t}\\ & ⋮\\ & Y_{Nt}={\alpha }_{1N}+\sum _{l=1}^{p_1}{\beta }_{1Nl}{Y}_{Nt-l}+\sum _{l=1}^{p_2}{\delta }_{1Nl}{X}_{Nt-l}+\sum _{l=1}^{p_3}{\phi }_{1Nl}{Z}_{Nt-l}+{\epsilon }_{1Nt}\end{array}$(11) are not the VAR but the SUR systems (Kónya 2006).

10. Whereas neoclassical growth theories explained economic growth with technological progress given exogenously, the “new” (endogenous) growth theories allow investigating the fundamental causes of economic growth and explaining why the immediate growth factors differ across countries (Acemoglu 2009).

11. In big economies higher demand, as a result of income growth, can be easier satisfied by domestic producers. This is due to the greater capacity and diversity of the output compared with the production factors endowments, both capital and labor, in relatively small economies. In other words, in tiny economies an increase in income is matched with imported production. Thus, bigger economies are more prone to adopt an inward-oriented strategy of growth, which not only allows them to explore economies of scale, but also eliminates foreign trade risks, e.g. related to the exchange rate fluctuations (Frankel and Romer 1999).

Additional information

Notes on contributors

Paweł Kawa

Paweł Kawa, PhD, researcher at the Department of Macroeconomics at the Cracow University of Economics, Poland.

Marta Wajda-Lichy

Marta Wajda-Lichy, PhD, researcher at the Department of Macroeconomics at the Cracow University of Economics, Poland.

Kamil Fijorek

Kamil Fijorek, PhD, researcher at the Department of Statistics at the Cracow University of Economics, Poland.

Sabina Denkowska

Sabina Denkowska, PhD, researcher at the Department of Statistics at the Cracow University of Economics, Poland.