Causal nexus between economic growth, banking sector development, stock market development, and other macroeconomic variables: The case of ASEAN countries
| Published date | 01 November 2014 |
| Author | John H. Hall,Sahar Bahmani,Mak B. Arvin,Rudra P. Pradhan |
| DOI | http://doi.org/10.1016/j.rfe.2014.07.002 |
| Date | 01 November 2014 |
Causal nexus between economic growth, banking sector development,
stock market development, and other macroeconomic variables: The
case of ASEAN countries
Rudra P. Pradhan
a,
⁎, Mak B. Arvin
b
, John H. Hall
c
, Sahar Bahmani
d
a
Vinod GuptaSchool of Management, IndianInstitute of TechnologyKharagpur, WB 721302, India
b
Departmentof Economics, TrentUniversity, Peterborough,Ontario K9J 7B8,Canada
c
Departmentof Financial Management,University of Pretoria,Pretoria 0028, SouthAfrica
d
Departmentof Economics, Universityof Wisconsin at Parkside,Kenosha, WI 53144,USA
abstractarticle info
Articlehistory:
Received16 March 2014
Receivedin revised form 24 June 2014
Accepted21 July 2014
Availableonline 1 August 2014
JEL classification:
O43
O16
E44
E31
Keywords:
Bankingsector
Stockmarket
Economicgrowth
Grangercausality
ASEANcountries
Thispaper examinesthe relationshipbetweenbanking sectordevelopment,stock marketdevelopment,economic
growth,and four other macroeconomicvariables in ASEAN countriesfor the period 1961–2012.Using principal
component analysisfor the construction of the developmentindices and a panel vector auto-regressive model
for testing the Granger causalities, this study finds the presence of both unidirectional and bidirectional causality
links between thesevariables. The study contributes to understandingthe importance of the interrelationship
betweenthe variables andcombines the differentstrands of the literature. Italso contributesto the literature by
focusingon a group of countries that have notbeen studied before. One particularpolicy recommendationis to
make the banking sector more accessible for those country's inhabitants that do not have bank accou nts.
Anotherpolicyrecommendationis tonurture stockmarket development,whichwill facilitatetheincreasedraising
of capitalfor investmentpurposes to enhanceeconomic growth.
© 2014 ElsevierInc. All rights reserved.
1. Introduction
The levelof banking sector developmentand stock market develop-
ment is amongthe most important variablesidentified by the empirical
economic growth literature a s being correlated with growth perfor-
mance across countries (Fink , Haiss, & Vuksic, 2009; Beck & Levine,
2004; Garcia & Liu,1999; Levine & Zervos, 1998; Naceur & Ghazouani,
2007;Yartey, 2008). These developmentchallengesprevent developing
countries from taking full adv antage of technology transfer, causing
some of these countries to diverge from the growth rate of the world
production frontier (Aghion, Howit, & Mayer-Foulkes, 2005; Menyah,
Nazlioglu, & Wolde-Rufael, 2014). In fact,it is debated that poor coun-
tries with a weakened financial system are trappedin a vicious circle,
where low levels of financial development, in both the banking sector
and the stock market,lead to low economic performanceand low eco-
nomic performance leads to low financial development (Fung, 2009).
An inadequatelysupervised financial systemmay be crisis-prone, with
potentially devastating effects (Moshirian & Wu, 2012; OECD, 1999).
On the contrary, an efficient financial system, with a well-developed
and integratedbanking sector and stock market,provides better finan-
cial services, which enables a n economy to increase its growth rate
(Bencivenga, Smith, & Starr, 1995; Esso, 2010; King& Levine, 1993a).
Hence,finance is not only pro-growthbut it is also pro-poor,suggesting
that financial development helpsthe poor catch up with the rest of the
economyas it grows (Demirguc-kunt& Levine, 2009).Furthermore, the
endogenousgrowth theory as articulatedby Greenwood and J ovanovic
(1990)and Bencivengaand Smith (1991) andothers stresses thatfinan-
cial development, bothbanking sector development and stock market
development,is a key factor that fosters long-runeconomic growth, as
financialdevelopment along with advancement is able to facilitateeco-
nomic growth through multiple ch annels. These channels include:
(i) providing information about possibleinvestments, so as to allocate
capital efficiently; (ii) monitoring firms and exert ing corporate
Reviewof Financial Economics 23 (2014)155–173
⁎Correspondingauthor.
E-mailaddresses: rudrap@vgsom.iitkgp.ernet.in(R.P. Pradhan),marvin@trentu.ca
(M.B. Arvin),john.hall@up.ac.za(J.H. Hall), bahmani@uwp.edu (S. Bahmani).
http://dx.doi.org/10.1016/j.rfe.2014.07.002
1058-3300/©2014 Elsevier Inc. All rightsreserved.
Contents listsavailable at ScienceDirect
Review of Financial Economics
journal homepage: www.elsevier.com/locate/rfe
governance; (iii) risk diversification; (iv) mobilizing and pooling sav-
ings;(v) easing the exchangeof goods and services;and (vi) technology
transfer (see,for example, Drake, 1980;Fritz, 1984; Garcia & Liu, 1999;
Levine,2005;Zhang,Wang,&Wang,2012).
Not surprisingly, the relationship between financial development
1
and economic growth has been an im portant area of discussion
among researchers andpolicy makers (see, for instance, Levine, 1999;
Luintel & Khan, 1999; Al-Yousi f, 2002; Ang, 2008a,b; Bangake &
Eggoh, 2011;Beck, Levine, & Loayza, 2000;Chow & Fung, 2011; Fase &
Abma, 2003; Herwartz & Walle, 201 4; Jung, 1986; King & Levine,
1993a,b; Levine, 2003; Levine, Loayza, & Beck, 2000; Mukhopadhyay,
Pradhan, & Feridun, 2011; Wachtel , 2003; Rousseau & Yilmazkuday,
2009; Yucel, 2009). However, what re mains unclear is the issue of
cointegration and causalitybetween banking sector development and
stock marketdevelopment. Developmenteconomics studies two types
of relationships: first, the link betwe en banking sector development
and economic growth (Christopoulos & Tsionas, 2004; Majid &
Mahrizal, 2007; Menyah et al., 2014 ; Moshirian & Wu, 2012; Tang,
2005); and second, the link between stock market developmen t and
economic growth (Choong, Yusop, La w, & Venus, 2003; Khan, 2004;
Levine, 1991; Singh, 1997). In a broad-spectrum, both banking sector
development and stock market developmentare main forces that can
bring about high economic growth in a country (Bilson, Brailsford, &
Hooper, 2001; Castaneda, 2006; Fink, Haiss, & Vuksic, 2006; Garcia &
Liu, 1999; Gjerde & Saettem, 1999; Kwon & Shi n, 1999;
Nieuwerburgh, Buelens, & Cuyvers, 2006; Pagano, 1993; Schumpeter,
1911; Shan, Morris, & Sun, 2001;Shaw, 1973; Trew, 2006). It has been
argued in a subset of the finance-growth literature that both banking
sector development and stock mark et development can cause each
other (Allen, Gu, & Kowalewski, 2 012; Cheng, 2012; Gimet &
Lagoarde-Segot,2011). While policymakersmay vary on the degree to
which these financial-sector deve lopments contribute to economic
growth, they generally concur that both do in fact matter. As a result,
many countries have adopted developmen t strategies that prioritize
bankingsector developmentand stock market development.ASEAN re-
gional forum (ARF) countries are no exception. Since the end of the
1980s, these countries have bolstered their banking sector and stock
market evolutionby reducing governmental interventionin the finan-
cial sector, generally,and in the banking sectors and/or stockmarkets,
in particular. Such policiesare expected to promote economic growth,
among other things, through the en hanced mobilization of savings
and increases in domestic and fo reign investment (King & Levine,
1993a; Levine & Zervos, 1996; Masih & Masi h, 1999; Reinhart &
Tokatlidis,2003; Thornton, 1994). However, to ascertainthat such pol-
icies are undeniably guaranteed to be effective, it must be formal ly
established thatthere is indeed a causal relationship betweenbanking
sector development, stock market development,and economic growth
(Cheng, 2012; Choe & Moosa, 1999; C ole, Moshirian, & Wu, 2008;
Colombage, 2009; Gries,Kraft, & Meierrieks, 2009; Hassan, Sanchez,&
Yu, 2011; Naceur & Ghazouani, 2007; Pan opoulou, 2009; Rousseau,
2009; Zivengwa, Mashika,Bokosi, & Makova, 2011; Zhanget al., 2012).
In this paper, we seek to answer questions concerning the nature of
the causal relationship between economic growth, banking sector devel-
opment, stock market development, and four other macroeconomic
variables. The novel features of this study are that: (1) we use the
group of 26 ARF countries over a long span of time, from 1961 to 2012;
(2) we combine the different strands of the literature; and (2) we em-
ploy principal component analysisand a panel vector auto-regressive
(VAR) model for testing the Granger causalities. These formulations are
rarely used in the finance-growth literature.
The remainder of this paper is structur ed as follows: Section 2
provides a literature review on the connection bet ween banking
sector development, stockmarket development,and economic growth.
Section 3 highlights the rese arch questions and the proposed
hypotheses. Section 4 presen ts the data structure, sample selection,
and the variables. This isfollowed by Section 5, which outlines ourem-
pirical model.Results are discussed inSection 6, while the final section
concludeswith a summary and the policy implicationsof our results.
2. Literaturereview
Financial development is pivot to economic growth (Graff, 2003;
Levine, 1997).The connection between the two variables has been the
focus of an immense body of theoretical and empirical research since
the seminal work Schumpeter (1911).A number of studies (Blackburn
& Hung, 1998; Beck & Levine, 2004; Beck et al. , 2000; Berthelemy &
Varoudakis, 1996; Craigwell, D ownes, & Howard, 2001; Dritsakis &
Adamopoulos, 2004; Fase & Abma, 2003; Fun g 2009; Greenwood &
Bruce, 1997; Greenwood & Smith, 199 7; Gregorio & Guidotti, 1995;
Herwartz & Walle,2014; Hsueh, Hu, & Tu, 2013; King& Levine, 1993a,
b; Pradhan, 2013; Rajan & Zingale s, 1998; Thornton, 1994; Uddin,
Shahbaz, Arouri, & Teulon, 2014) ex amined the effect of financial
development and economic growth u sing a number of econometric
techniques, such as cross-sectional, time series, panel data, and firm-
level studies.
2
By large, the empirical evidence had demonstrated that there is a
positivelong-run association between the indicatorsof financial devel-
opmentand economic growth.In general, allthese papers suggestthat a
well-developed financial system is growth-enhancing, and hence, con-
sistent with the proposition of “more finance, more gr owth”(Law &
Singh,2014). At the same time,focus on causality betweenfinancial de-
velopment and economic growth ( i.e., the finance-growth link) has
spawned considerable interestamong economists in recentyears. Sub-
sequently,there have been many similarstudies in this regard forboth
developed anddeveloping countries. While mostof these studies have
confirmedthe existence of a causal relationship from financialdevelop-
ment to economic growth (Enisan & Olu fisayo, 2009; Hassan et al.,
2011; Menyah et al.,2014; Pradhan, Dasgupta et al., 2013; Rousseau &
Wachtel, 2000), there are a few cases whe re there is no evidence of
causality from financial developm ent to economic growth (Eng &
Habibullah, 2011; Lucas, 1988; Mukhopadhyay et al., 2011; Pradhan,
Mukhopadhyayet al., 2013; Stern, 1989). Hence, the empirical studies
on the relationship between fina ncial development and economic
growth donot provide any definite conclusion on the natureand direc-
tion of this relationship and currently th ere is no consensus among
economists about the nature of this relation ship. In summary, there
are fourpossible relationshipsthat have been emphasizedin the empir-
ical literature on the causal link betwee n financial development and
economic growth, namely the unidirectional financ ial development-
led growth hypothesis, the unid irectional growth-led financial
development hypothesis, the feedbackhypotheses, and the neutrality
hypothesis.
In response to theabove focus on finance-growth nexus,this paper
examines the nexusin the ARF countries. Specifically,we define finan-
cialdevelopment as both bankingsector developmentand stock market
development and study their impact on economic growth along with
1
Financialdevelopmentis defined in terms of the aggregatesize of the financial sector,
its sectorial composition, and a range of attributes of individual sectors that determine
their effectivenessin meeting users' requirements. The evaluation of financial structure
shouldcover the rolesof the key institutionalplayers,including the centralbank, commer-
cialand merchant banks,saving institutions,developmentfinancial institutions,insurance
companies,mortgageentities, pensionfunds, the stockmarket, and otherfinancial market
institutions (see,for instance, IMF, 2005, Chap. 2; Zaman, Izhar, Khan, & Ahmad, 2012).
Thus, financialdevelopment includesboth banking sectordevelopment and stockmarket
development.
2
Levine (2003)provides an excellent overview of a large body of empirical literature
that suggests that financial development can robustly explain differences in economic
growthacross countries.
156 R.P.Pradhan et al. / Review of FinancialEconomics 23 (2014)155–173
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