Financial Development and Economic Growth: Panel Data Analysis

Financial Development and Economic Growth: Panel Data Analysis

Filiz Eryılmaz (Uludağ University, Turkey), Hasan Bakır (Uludağ University, Turkey) and Mehmet Mercan (Hakkari University, Turkey)
DOI: 10.4018/978-1-4666-7288-8.ch015
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The relationship between financial development and economic growth has been the subject of considerable debate in development and growth literature. Therefore this chapter provides evidence on the role of financial development in accounting for economic growth in 23 OECD countries (Italy, Japan, Luxemburg, Holland, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, England, USA, Australia, Austria, Belgium, Canada, Denmark, Finland, Turkey, France, Germany, Greece, Iceland) via panel data analysis using the annual data for the period 1980-2012. The authors find a positive relationship between financial development and economic growth for all countries. Also this result means that financial development leads economic growth in these countries. So the results may help policymakers formulate effective financial sector policies as a tool to promote economic growth.
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Together with the rapidly developing globalization which has been ongoing since the 1970s, the neo-liberal policies such as privatization, deregulation, liberalization and global integration which define the economic policies of countries have started to be applied intensively in the form basic elements. The most noteworthy of these policies is financial liberalization, in other words the removal of controls on banking and other financial tools. With the aid of financial liberalization in the 1980s, countries started to achieve conformity and integrity with the globalised world economy. Thus, with the diversity of a country’s financial market tools, the great increase in the funds in circulation, the development of new financial markets, innovations in technology and the field of communications have provided financial procedures at an international level and much lower transactional costs (Berkman, 2011: 260).

Together with these developments, the increased economic growth created by financial development and the relationship between financial development and economic growth has started to attract great interest from economists and many studies have been conducted on this subject (Dinar, 2012: 111). Parallel to this interest in literature, this study researched the relationship between economic growth and financial development in the period 1980-2012 of 23 OECD countries for panel data analysis. The results obtained from the analysis confirmed a positive relationship between financial development and economic growth.

After presenting the theoretical framework of the relationship between financial development and economic growth in the second part of the study, the third section of the study refers to the importance in literature. After the separation of data and methodology in the fourth part, the final section summarizes the findings and conclusions.

Key Terms in this Chapter

Endogenous Growth Model: The model holds that economic growth is primarily the result of endogenous and not external forces. Endogenous growth theory holds that investment in human capital, innovation, and knowledge are significant contributors to economic growth. The theory also focuses on positive externalities and spillover effects of a knowledge-based economy which will lead to economic development.

Financial Market: A financial market is a market in which people and entities can trade financial securities, commodities, and other fungible items of value at low transaction costs and at prices that reflect supply and demand. Securities include stocks and bonds, and commodities include precious metals or agricultural goods.

Financial Development: Financial development is part of the private sector development strategy to stimulate economic growth and reduce poverty. overcoming “costs” incurred in the financial system. This process of reducing costs of acquiring information, enforcing contracts, and executing transactions results in the emergence of financial contracts, intermediaries, and markets. Different types and combinations of information, transaction, and enforcement costs in conjunction with different regulatory, legal and tax systems have motivated distinct forms of contracts, intermediaries and markets across countries in different times.

Unit Root Test: In statistics, a unit root test tests whether a time series variable is non-stationary using an autoregressive model. A well-known test that is valid in large samples is the augmented Dickey–Fuller test.

Panel Data Analysis: A statistical method, widely used in social science, epidemiology, and econometrics, which deals with two-dimensional panel data. The data are usually collected over time and over the same individuals and then a regression is run over these two dimensions.Multidimensional analysis is an econometric method in which data are collected over more than two dimensions.

Financial Fragility: The vulnerability of a financial system to a financial crisis.

Economic Growth: An increase in the capacity of an economy to produce goods and services, compared from one period of time to another. Economic growth can be measured in nominal terms, which include inflation, or in real terms, which are adjusted for inflation. For comparing one country's economic growth to another, GDP or GNP per capita should be used as these take into account population differences between countries.

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