Three comments are in order. First, our TL and FL indexes do not allow for policy reversals: once a country liberalizes, it never becomes closed thereafter. This means that our indexes do not capture some policy reversals that might have occurred in the latter part of the 1990s. Since our sample period is 1980-99, we consider our approach to be the correct one for analyzing the effects of liberalization on long-run growth and financial fragility. 74 Second, in comparing different indexes it is convenient to distinguish liberalization from openness indexes. The former identify the dates of financialliberalization, whereas the latter measure the amount of capital flows that a country receives over a certain period. For instance, Bekaert, Harvey, and Lundblad (2001) and Kaminski and Schmukler (2002) consider liberalization indexes as we do, whereas Kraay (1998), Lane and Milesi-Ferretti (2002), and Edison and others (2002) consider openness indexes. Finally, the country- years identified as financially liberalized by our index, as well as the other liberalization indexes, do not necessarily coincide with “good times,” because they include both boom and bust country-years. Therefore they are not subject to the criticism that liberalized country-years coincide with good times. The liberalization dates are reported in table B1.
Theoretical and empirical research indicates a strong and positive correlation between trade liberalization and economic growth over long period of time. Sachs and Warner (1995) has pointed out that open economies has grown about 2.5 per cent faster than closed economies and the difference is larger among developing countries. Jin (2000) argued that trade liberalization and openness has provided an important base of economic activity. Thus, an increasing openness is expected to have a positive impact on economic growth. 16 Barro (1991) provided evidence that increasing openness had a positive effect on GDP growth per capita. Edwards (1992) also found a positive and significant effect of openness on GDP growth. It can be argued that through the openness countries are able to benefit from information spillovers such as scientific advances and improvements. Sukar and Ramakrishna (2002) argued that countries that liberalize their external sector and reduce impediments to international trade can experience relatively higher economic growth. Thus, we extend equation (1) by incorporating the variable TOPEN which capture the impact of trade liberalization on real output. Now equation (1) can be written as:
By the end of the twentieth century, governments of industrial countries had virtually eliminated all policies hindering the movement of financial capital across their borders. Basic economic theory suggests ways in which capital account liberalization may benefit a country: Free capital mobility offers the opportunity to realize the highest return on saving, to borrow at the most favorable rates, and to diversify away country- specific risk. 1 A more subtle set of benefits, but ones that have increasingly been the focus of discussion, pertain to the impact of capital account liberalization on the efficiency and development of a country’s financial system. The potential relevance of this channel is highlighted by recent work on the importance of financial development for economic growth. 2
The process of liberalization and opening up capital markets for trade was started in 1970’s right after Turkey fell into foreign debt payment problems. The stabilization program and policies were made under International Monetary Fund to control over those problems. First of all, foreign trade was liberalized in 1980's. January 24, 1980 decision known as the stabilization program opens the door to the process of liberalization of experience of Turkey’s financialliberalization has been the subject of many scientific studies from different angles. In this context, research can be divided in two areas. Firstly, by determining investment and savings functions, the effect of financialliberalization on saving and investment is estimated (Erol, 1992). Secondly, the contribution of financialliberalization to economic growth is examined. In this context, the studies focused on determining the relationship between financial deepening and economic growth indicators and in the vast majority of these studies, analysis of causality is used (Akçoraoğlu, 2000). This was followed by foreign exchange trade liberalization in 1984. Istanbul Stock Exchange was reopened in 1986. Central Bank began its open market operations in the following year. Control on capital movements were removed in 1989 and Turkish Lira became convertible which meaned the beginning of financialliberalization by making the economy financially open to foreign trade.
The study set out to ascertain the extent to which the MS hypothesis is borne out of South African economic data. This was with a view to establishing the extent of relationships between financialliberalization, financial development and economic growth. There was a review of theoretical and empirical literature. In this task there was an analysis of the financial sector and the real economy, the money transmission mechanism, financial repression its types and rationale. This gave way to a discussion of literature on the MS hypothesis which laid the ground for an analysis of the nexus between financialliberalization, financial development, interest rates and economic growth. And lastly, a look at how financialliberalization may affect the greater economy through literature on the interaction of monetary policy and financialliberalization Empirical studies have generally split the study into three main segments: savings and interest rates (Micksell and Zinser, 1973; Giovannini ,1985 and Gupta,1987).Secondly, credit availability and investment (Fry, 1981; Greene and Villanuaeva, 1991). And, lastly the growth link (Levine and Zervos, 1998; Ang Bonfiglioli, 2005 and McKibbin, 2007). The section focusing on savings and interest rates showed that there was general consensus in the studies that there existed a long run stable relationship between savings and investments. Moreover, there was consensus that savings caused investment. The second segment focuses on credit availability and investments as an outgrowth of financialliberalization. Here it is shown that financialliberalization has effects on other facets of the economy other than savings, interest rates and economic growth. There are also empirics to support that credit availability creates positive factor productivity and capital accumulation (Bonfiglioli, 2005).
As emphasized in the methodological review, it is central to treat the endogeneity of political instability in the growth regression. This is also vital with respect to financialcrises, when examining the determinants of political instability in the first analysis. Four potential solutions were evaluated. First, the analysis could have been performed as simultaneous equations, with growth and political instability as dependent variables and each others main explanatory variables, and financialcrises as a common explanatory variable. Because of the operationalization of political instability into four dimensions (see section 4.2), this would be very complicated. A second alternative is to use external instruments, but taking the warning by Durlauf et al. (2004) about the difficulty of finding good instruments into account, this option is ruled out. As a third possibility, the opportunity of using internal instruments was evaluated. Jong-A-Pin (2009) employ the system-GMM estimator, as proposed by Arellano and Bover (1995) and Blundell and Bond (1998), where the endogenous explanatory variables are instrumented by up to t-2 lagged versions of themselves. Due to the unbalanced panel used in this thesis, and the large loss of data points this technique causes, it is dismissed (see section 4.0). The chosen technique is also the simplest. The endogenous variables will be lagged by one year, in order to ensure that the direction of causality run in the right direction. This alternative provides less loss in degrees of freedom than internal instruments, it is far simpler than finding external instruments, and more parsimonious than simultaneous equations.
However, as observed by the World Bank (2011) report on growth prospect in Africa the future looks bright for African economies. But, in order to avert the detrimental effect of financialcrises; appropriate responses will be critical. Such response will include deepening the domestic capital and foreign exchange markets which will enhance African economies capacity to handle external financial volatility over the long term; building robust regional markets; the government revisiting the development role of the state by unleashing the potential of local business and entrepreneurs for development; strengthening of crisis contingency planning and preparedness; maintenance of prudential regulations as well as more communication among regulatory authorities across borders; instituting market-conform mechanisms to preserve access to finance, especially for small and medium scale enterprises etc. It is only when these measure and others are pursued at the highest level of governance that African countries can come through financial crisis, better off.
It is generally accepted in the financialliberalization literature that liberalizing the financial system could play a vital role in economic development. Therefore, the main focus of this work is to examine empirically the effect of financialliberalization on Nigeria’s economic growth for the period 1987 to 2012. Employing essentially, the Johansen Co-integration test and Error Correction Models (ECM) as econometric tools, the result of the study shows that financialliberalization has impacted positively on economic growth in Nigeria. This is in line with the main tenets of financialliberalization thesis as laid out by McKinnon (1973) and Shaw (1973). The study also shows that financialliberalization has helped to ease the binding constraints on investment funding as investors have benefitted from interest rate deregulation as they seek investment funding from financial institutions in the country. The deregulation of exchange rate occasioned by financialliberalization has also had salutary effects on economic growth in Nigeria for the period under review. Moreover, against all odds and expectation, inflation has proved to be beneficial to the economy of the country for the period under review. The inflationary trend may have motivated investors to invest more in anticipation of favourable price and income. These have combined to raise employment and income levels in the country. Therefore, macroeconomic instability which is associated with inflationary trend has not negatively impacted economic growth as expected but have achieved the opposite, perhaps by default.
It is evident that there is no support for the presence of a non-linear effect, implying that a threshold effect does not exist in the relationship between aid and per capita real GDP for India. Apart from the measure of stock market volatility, all other control variables and their interaction terms are found to be statistically insignificant. For instance, the effectiveness of aid on growth in India does not depend on the presence of a good institutional framework such as strong intellectual property rights protection – a finding consistent with Easterly et al. (2004) and (Alvi et al., 2008). Moreover, the measures of financial development are found to have no effect on per capita GDP. This is probably due to the inclusion of the financialliberalization index in the specification as studies have shown that financialliberalization is an important determinant of financial development (e.g., see Ang and McKibbin, 2007; Ang, 2008a).
We therefore concluded that both unrestricted co-integrating rank test (Trace) and unrestricted co-integrating rank test (Max-Eigen) confirmed the presence of co-integrating equations. Hence, there is a long run relationship between financial development and Nigeria’s economic growth implying that financial sector development plays a crucial for attaining sustainable growth and development in Nigeria particularly in the era of financialliberalization.
Table 12 shows that for all samples convergence is stronger when the liberalization in- dicator is included reaching a maximum of 0.0104 in the largest sample for the model that includes banking development indicators. This is consistent with the Sachs and Warner (1995a) argument that efficient economic institutions are necessary for economic growth and therefore for economic convergence. In other words, they believe that efficient economic institutions are important determinants of long-run growth and that the failure to observe convergence for the poorest countries is reversible by adopting the right policies. Although they focus on trade openness, we show that financialliberalization may be equally important. Sachs and Warner (1995a) also show that trade-liberalized countries as a group show stronger convergence than closed economies. In our regression framework, this suggests an interaction variable between the liberalization indicator and initial GDP. The result is reported in panel A of Table 13. The convergence coefficient for the liberalized countries equals the coefficient on the initial GDP plus the coefficient on the interaction variable. For samples I and II, the interaction variable is significantly negative suggesting stronger convergence among liberalized economies than among segmented ones. For samples III and IV, there is no significant effect, perhaps because these samples are somewhat more homogeneous to start with, containing only economies with a certain level of equity market development.
The specification (2.1) means that we are looking for a growth effect of financial liberaliza- tion and integration on top of the growth effect of financial development. This is important to keep in mind since a possible channel through which international financial integration can affect growth is by enhancing the performance of the domestic financial sector (see, e.g., Le- vine and Zervos, 1998, Klein and Olivei, 1999, and Levine, 2001). Throughout the analysis we also split the country sample according to the level of financial development, having one group of countries above and one group below the median level of financial development. The background is the recent findings (e.g., Laeven, 2000; Edwards, 2001) that the impact of fi- nancial liberalization on growth may depend on the level of financial development in a coun- try. 2 Basically, this is mainly due to the fact that developed economies are better able to make productive use of new capital inflows than are emerging market economies. There is, how- ever, no broad consensus along these lines and few studies have actually examined this im- pact.
The liberalization thesis has generated a lot of debate in theoretical and empirical literature. In this paper we construct an index of financialliberalization from 1981 to 2012 to investigate its impact on economic growth in Nigeria using the McKinnon–Shaw framework. The ordinary least squares methodology and cointegration analysis are adopted in the study. The result reveals that financialliberalization (FINDEX) and private investment (PINV) have significant positive impact on economic growth in Nigeria. However, real lending rate (LDR) proved to be negatively related to economic growth in Nigeria within the period under review. We therefore conclude that the monetary authorities and policy makers in Nigeria need to support the liberalization process by formulating complementary policies and financial sector reform measures that will help in strengthening the impact of the liberalization process on the economy and also ensure that the benefits of the liberalization exercise is maximized.
We investigate three types of reforms: macro-reforms, financial reforms and legal reforms. We do not have sufficient information to determine the exact time lines of reforms for all our countries in most instances. Consequently, we follow an indirect approach by inserting as control variables into our growth regression continuous variables that measure the direct effect of the reforms. An example would be the level of inflation for macro-reforms. The third bloc of variables examined in Table 2 comprises the variables used in this section. Table 2 shows that indeed in most instances these variables change in the required direction after an equity liberalization, and that liberalized economies score better on measures of macro-economic stability, financial development and rule of law. This is an indication of the potential simultaneity of reforms directly affecting these variables on the one hand and equity market liberalization on the other hand or it may be that equity market liberalization contributes to a better macro-economic environment, promotes financial development or in- stigates legal reforms that improve the legal environment. In fact, Rajan and Zingales (2003) point out that financial development may be blocked by groups (incumbents) interested in maintaining their monopoly position (in goods and capital markets). They argue that this is less likely to be the case if the country has open trade and free capital flows and hence financial openness may instigate other reforms.
Several emerging countries and also the Latin America and Caribbean region uniquely favorable external conditions—including the price of raw materials, low interest rates, and a series of positive outcomes deriving from the reforms of the 1990s (e.g., the strengthening of legal and regulatory frameworks, fiscal consolidation, and financialliberalization) 61 —provide a distinctive opportunity for the continuation of the financial sector reform. If the overall strategy and sensible policies—including extensive credit information, a solid supervisory framework and capacity, strong disclosure provisions supported by adequate accounting standards, and increased market discipline— continue to be put in place, we may see that “collateral benefits and threshold conditions” to which Kose and others 62 refer would provide a better path to financial sector development and that the trade-offs of financialliberalization—growth and stability— would lose much of their effect.
Abstract: Development economists have long recognized the role of the financial system in the process of economic development. Financial institutions and markets anticipate future growth opportunities, were financial development tends to accelerate growth through new firm formation, increasing access to external financing and boost firm growth. Using Industry level time series data, following Rajan and Zingales (1998), methodology we empirically examined the links between financial sector development, financial structure and industry growth for the post-reform period. The results suggest a positive influence of financial development (FD), and negative influence of financial structure (FS), on the rate of growth of value added of the Industries. One of the contributions of this study is the examination of the influence of industry competitiveness (export intensity and import intensity) and financialliberalization on industry growth where export oriented industries are relatively more dependent on external finance for their growth. Regarding liberalization the results doesn’t show any direct effect on industry growth in value added.
We have tried to explore the link between financialliberalization index (FLI) and economic growth in Pakistan by using annual data for 1971- 2007. The Phillips Perron unit root test is utilized to verify the level of integration and Auto-Regressive Distributed Lag (ARDL) technique for obtaining long run and short run coefficients. The empirical finding indicates that FLI and economic growth are positively linked in the short run. On the other hand, FLI is statistically insignificant in the long run, while the impact of real interest rate (RIR) on economic growth is negative and significant. This means that one unit increase in the RIR causes GDP to decline by Rs. 1.03 million. Our investigation recommends that SBP and the GOP should pursue financialliberalization policies that are consistent with economic growth.
Notes: Robust standard errors clustered at country⁎time level in brackets; ⁎ signiﬁcant at 10%; ⁎⁎ signiﬁcant at 5%; ⁎⁎⁎ signiﬁcant at 1%. The dependent variable is the average growth rate of the number of establishments, total employment, capital stock, and TFP during the 10 years immediately before or immediately after an episode of ﬁnancial liberalization. Treated takes on the value of 1 if a liberalization event took place in a country, and zero otherwise. Post takes on the value of zero before the liberalization event, and 1 after, for all countries irrespective of whether they liberalized. Initial share is the beginning-of-period share of output in a sector in total manufacturing output. Exports/output and Imports/ output are the exports and the imports in the sector divided by the total output in the sector. Private credit is the private credit by banks and other ﬁnancial institutions as a share of GDP. Extern. ﬁn. is the sector-level measure of reliance on external ﬁnance. In columns (1), (3), (5), and (7) the control group consists of all countries (within the group of OECD/non- OECD) that did not liberalize within the 20-year period. In columns (2), (4), (6) and (8) the control group is the country selected by the propensity score matching procedure (PSM). All speciﬁcations are estimated using OLS, and including the ﬁxed effects speciﬁed in the table. Variable deﬁnitions and sources are described in detail in the text.
To summarise, the above review of empirical evidence on capital account liberalisation, capital inflows and the growth of GDP and its volatility indicates that there is a close relationship between liberalisation and economic and financialcrises. This relationship is robust and in the circumstances of developing countries there are also strong analytical arguments for both its existence and robustness. On the other hand available evidence does not indicate that free capital flows necessarily lead to faster long-term economic growth for the typical developing country. In view of these facts, Stiglitz (2000) is fully justified in castigating the IMF for its promotion of capital account liberalisation. Not only is there no adequate theoretical or empirical case for such espousal but there is in fact a strong case against it. Indeed the economic crises and the instability which capital account liberalisation is seen to generate, may compromise a country's future economic development by inducing capital flight and lowering domestic investment and long-term economic growth.
As can be seen in Table 1, the past growth rate impacts significantly on current growth, mostly the first lag. Moreover, the current coefficient of the dummy capturing current financialcrises is significant and negative, indicating a reducing effect of financialcrises on current growth. Finally, results suggest that nominal exchange rate regime changes do not significantly impact on current growth, being in line with Sosvilla-Rivero and Ramos-Herrera (2014) who contend that, for high-income countries, there are not significant differences in economic growth between exchange-rate regimes.