Comparative study on finance‐growth nexus in Malaysia and Indonesia: Role of institutional quality

• Author: Grahita Chandrarin,S. M. Riad Shams,Normah Omar,Kazi Sohag
• Date: 01 September 2019
• DOI: http://doi.org/10.1002/jsc.2293
• Published date: 01 September 2019

RESEARCH ARTICLE

Comparative study on finance-growth nexus in Malaysia and

Indonesia: Role of institutional quality

Kazi Sohag

1,3

| S. M. Riad Shams

2

| Normah Omar

3

| Grahita Chandrarin

4

1

Graduate School of Economics and

Management, Ural Federal University,

Ekaterinburg, Russia, Russia

2

Newcastle Business School, Northumbria

University, UK

3

Accounting Research Institute, Universiti

Teknologi MARA, Shah Alam, Malaysia

4

Graduate School, University of Merdeka

Malang, East Java - Indonesia

Correspondence

Graduate School of Economics and

Management, Ural Federal University, Kazi

Sohag, Room 209A, Gogolya

St. 25, Ekaterinbourg 620075, Russian

Federation.

Email: sohagkaziewu@gmail.com

Abstract

The impact of financial development (FD) on economic growth in the context of

Malaysia and Indonesia has been examined in this study regarding the role of the finan-

cial crisis and strategic changes in the institutional setup. Autoregressive distributed lags

and threshold regression were applied, and time series data were analyzed for the

period between 1984 and 2017 revealing that FD promoted the economic growth in

both economies during this period. A nonlinear analysis also revealed that FD and eco-

nomic growth follow an inverted U-shape relation in the case of Malaysia whereas, in

Indonesia, it followed a U-shape relation. It was discovered that not all measures of FD

promote economic growth. For instance, market capitalization was profound in the

Malaysian economy while credit to the private sector and money supply was conducive

for the Indonesian economy. The analysis demonstrated that the Asian and global finan-

cial crisis adversely affected economic growth in the case of Indonesia due to poor insti-

tutional quality (IQ), whereas in Malaysia it was relatively safe from the adversity

brought about by the financial crisis due to the presence of IQ and good corporate gov-

ernance. However, a positive change in IQ was found to have a much greater impact on

augmenting economic growth rather than playing a mediating role in connection with

FD and economic growth in Malaysia. In the context of Indonesia however, IQ was

found to impede economic growth but played a positive and significant mediating role

in the nexus of FD and economic growth. The spill-over analysis revealed that Malay-

sian FD is positively associated with Indonesian economic growth while Indonesian FD

is negatively associated with the Malaysian economy. This study provided all economic

and anecdotal explanations in supporting the results of this study.

1|INTRODUCTION

While the nexus between financial development (FD) and economic

growth has been extensively studied during the last few decades, the

results are comparatively inconclusive. There are four strands of liter-

ature that focus on finance-growth nexus. The first strand mainly

states the critical functioning of finance in accelerating growth intro-

duced by Schumpeter (1934). This view was later supported by Gurley

and Shaw (1955), McKinnon (1973), and Shaw (1973). Whereas,

Levine (1998) argued that the primary role of FD is to allocate

resources into the most productive sector and Goodhart (2004)

argued that financial market development reduces frictions in the

market. For instance, decreasing transaction and information costs

contribute to financial investment and economic growth.

The functional role of FD is to promote investment and economic

growth by facilitating the most productive allocation of resources (Levine,

1998). Recent studies document the positive role of FD in promoting eco-

nomic growth (Christopoulos & Tsionas, ; Dawson, 2008; Fink, Haiss, &

Vuksic, 2006; Levine, 1999; Menyah, Nazlioglu, & Wolde-Rufael, 2014;

JEL classification codes: B22, B26, C50, C22.

DOI: 10.1002/jsc.2293

Strategic Change. 2019;28:387–398. wileyonlinelibrary.com/journal/jsc © 2019 John Wiley & Sons, Ltd. 387