In this study, the impact of stock market and banking sector development on economic growth is investigated by applying mean and common mean group estimators on the sample from 1989 to 2013 for low human developed countries. The empirical findings represent that among the proxies of banking sector development only credit to private sector leaves positive and significant effect on economic growth in case when it interacts with all the three proxies of stock market development. However, traded stocks and turnover ratio are significantly enhancing economic growth in case when these interact with banking sector development. This study also finds that both stock market and banking sector development are together required to increase economic growth in low human developed countries.
This study also confirms the evidence of Lewis (1954) model for the selected countries. Lastly, this study proposes that credit to private sector from banking sector development in the light of stock market development must be given prime importance if economic growth is to be targeted in low human developed countries.
Keywords: Stock Market Development, Banking Sector Development, Economic Growth, Low Human Developed Countries
The importance of economic growth cannot be underestimated as it entails many welfare maximizing consequences. But what determines the rate of economic growth remains a debatable point. Variety of factors has been identified by the researchers1 but the debate is still far away from settlement. The factors identified are very much conspicuous in Harrod – Domar model, Solow model and endogenous growth model. One of such indicators identified is financial development. Although, the relationship between financial development and economic growth has been in the discussion from the past many years and researchers have been contributing in the academic literature by empirically exploring this relationship, yet the debate is unsettled that whether development of financial sector causes economic growth or it is growth process which leads to the development of financial sector.
The importance of well-developed financial system to achieve economic growth can be traced back in the Schumpeter (1911), Gurely and Shaw (1955) and Shaw (1973). The debate of growth-finance is then further divided into bank based and market based. Here enters the debate of complementarity and/or substitutability. As while talking about the financial intermediation one cannot set aside either market based or bank based system. So the researchers started to take into account both the markets. The association between financial market development and economic growth then moved in the arena of causality which demands the delineation that which causes which. Thus, another much debated question emerges that whether finance growth nexus is demand following or supply leading.
The literature suggests that if causal relationship runs from economic growth to development of financial sector then this will be named as demand following hypothesis, however, if the causal relationship runs from financial development to economic growth then it will be called as supply leading hypothesis.
Besides this, the relationship between output growth and financial development may also be bidirectional which shows that if financial development accelerates economic growth then resultantly economic growth will also expand financial sector development in any economy. Another important aspect of finance and growth relation is the impact of composite term of stock market development and banking sector development (both together represents financial development) on economic growth. This reveals that whether both sectors are complementary and hence are required together to elevate economic growth or this relationship will show that both sectors are substitutes to each other. This will conclude that at one time only one sector is to be focused to enhance economic growth.
In an empirical study, Cheng (2012) instead of using multiplicative interaction term, the author uses debt-to-equity ratio to explore the link between credit and equity markets. The author is of the view that an economy’s development accompanied by the increase of debt-to-equity ratio confirms whether two sources of finance are complementary to each other on not? The study concludes that in Taiwan the two sources are substitutes. Therefore, the present study introduces interaction term between stock market and banking sector development to investigate the joint effect of interaction term on economic growth and this will enable us to differentiate whether both sectors are complementary or substitutes to each other for promoting economic growth in low human developed countries classified in Human Development Report of UNDP (2013).
Therefore, the present study aims to investigate the impact of financial development in the form of both banking sector and stock market development on economic growth in low human developed countries using mean and common mean group estimators. This study will also capture the effect of interaction term between stock market and banking sector development on economic growth to see whether both sectors should be taken together to promote economic growth or should they be taken separately?
The remaining study will be carried out by discussing review of the past studies in the part – 2. In part – 3, data sources, models and estimation procedure will be presented. Afterwards, empirical results and their discussion will be discussed in part – 4. In the last and final part – 5, based on the findings of the study, conclusion and possible policy implications will be presented.
REVIEW OF LITERATURE
THE IMPACT OF BANKING SECTOR DEVELOPMENT ON ECONOMIC GROWTH
The effect of banking sector development on economic growth has been empirically tested by many researchers. The studies which capture the effect of banking sector development on economic growth are presented as below:
We start from the study of Moustain (2004) who after employing Johansen multivariate cointegration and Granger causality tests on sample period from 1970 to 2000 for Moroccan economy found absence of long run relationship between financial development and economic growth in Morocco. Moreover, the estimates of causality test for short run suggested that out of three proxies of banking sector development only domestic credit to private sector causes economic growth in Morocco. The study concluded that banking sector development was witnessed to be irrelevant for economic growth in Morocco. Khan et al. (2005) after using ARDL bounds testing technique on the sample period from 1971 to 2004, this study found that financial depth, real deposit rate and financial reforms have positive and significant impact on economic growth only in the long run in Pakistan.
Apergis et al. (2007) after applying panel causality test on sample period from 1975 to 2000 tested the impact of financial development on economic growth for 15 selected OECD and 50 selected non OECD countries (total 65 countries) and confirmed that proxies of financial development such as liquid liabilities, domestic credit to private sector and domestic credit provided by the banks to private sector have bidirectional causal relationship with economic growth in these selected countries. Afterwards, Perera and Paudel (2009) used Johansen multivariate cointegration and Granger causality tests on sample period from 1955 to 2005 and found unidirectional causality running from economic growth to narrow money, total credit and private sector credit as share of total credit and from private sector credit as share of per capita nominal GDP to economic growth.
The findings also confirmed bidirectional causal relationship between broad money supply and economic growth for Sri Lanka. This study confirmed evidence of demand following phenomenon for Sri Lanka. In another study Hassan et al. (2011) considering 168 low and middle income countries investigated the effects of different proxies of financial development like domestic credit to the private sector, domestic credit provided by the banks, liquid liabilities and savings on economic growth using sample period from 1980 to 2007. The empirical results confirmed evidence of bidirectional causal relationship between economic growth and financial development in most of the regions but, in the two poorest regions unidirectional causality was found from economic growth to financial development. This study concluded that financial development may be a necessary condition for accelerating economic growth rather than sufficient condition.
Okwo et al. (2012) considering M2 and domestic credit to private sector as proxies of financial sector development used least square regression and Granger causality tests on the sample from 1986 to 2010 and found that both measures of financial development may be important for strengthening financial development but these measures did not promote economic growth in Nigeria. Adu et al. (2013) using ARDL bounds testing approach on the sample period from 1961 to 2010 and confirmed long run relationship between financial development and economic growth in Ghana. Adusei (2013) after using GMM dynamic panel technique on the data series from 1981 to 2010 for 24 selected African countries concluded that domestic credit to private sector and liquid liabilities have significant and positive impact on economic growth in the selected African countries. The findings further concluded bidirectional causal relationship between measures of financial development and economic growth in the selected countries.
The study by Malki and Assaf (2014) using ARDL cointegration for the period from 1970 to 2008 and found that financial development in the form of bank deposit liabilities and credit to private sector has positive and significant effect on economic growth in the long run but, only bank...