Relationships between Financial Development, Trade Openness, and Economic Growth: Empirical Evidence for Turkey

Introduction

In empirical growth literature, degree of financial development (FD) and level of trade openness are amongst the most significant variables which affect growth performance (Barro, 1997; Beck, 2002). Particularly, over the last few decades, the relationship between finance and economic growth has attracted considerable attention in economic development literature. After 2007-2008 global economic crises, policy-makers and researchers have paid more attention to financial systems of the countries (Pan, 2013). Actually, the theoretical foundation of this relationship can be traced back to the work of Schumpeter (1911) defending that financial development encourages new production techniques. Recently, there is growing empirical evidence that FD contributes significantly to economic growth. The leading studies such as those of Goldsmith (1969), McKinnon (1973) and Shaw (1973), along with some recent important works, indicated that well‐functioning financial systems can contribute to economic growth in positive ways (see e.g. King & Levine, 1993; Demetriades & Hussein, 1996; Levine, 1997; Rajan & Zingales, 1998; Aghion, Howitt & Mayer-Foulkes, 2005). Some prominent theoretical studies also explain the positive effects through various functions of financial intermediaries (see e.g. Goldsmith, 1969; Patrik, 1966; Levine, Norman & Thorsten, 2000). For instance, according to Levine (1997), financial intermediaries (i) facilitate the trading and pooling of risk, (ii) allocate resources effectively, (iii) monitor managers and exert corporate control, (iv) mobilize savings, and (v) facilitate the exchange of goods and services. On the other hand, Robinson (1952) claims that financial development has no effect on economic growth. Moreover, economic growth may encourage the financial industry to provide better services, and thus economic growth can cause financial development rather than the other way. In addition, the evidences gained from many empirical studies on finance-growth nexus have been mixed and ambiguous depending on the choice of methodology employed and special features of the countries.