Finance and growth in oil‐dependent economies: does crude oil price matter? evidence from Nigeria

• Author: Chinazaekpere Nwani
• Date: 01 December 2016
• DOI: http://doi.org/10.1111/opec.12086
• Published date: 01 December 2016

Finance and growth in oil-dependent

economies: does crude oil price matter?

evidence from Nigeria

Chinazaekpere Nwani

Department of Economics, Banking and Finance, Gregory University Uturu, P.M.B. 1012, Uturu, Abia State,

Nigeria. Email: c.nwani@rgu.ac.uk

Abstract

This study examines three possible causal relationships between financial sector development,

economic growth and crude oil price in Nigeria using the Autoregressive Distributed Lag (ARDL)

approach to cointegration analysis over the period 1981 to 2011. First, the causal effect of financial

sector development on economic growth is found to be negatively insignificant in the long-run and

negatively significant in the short-run suggesting the weakness of financial intermediary sector in

resource mobilisation and allocation in Nigeria. Crude oil price is found to be the key driver of

economic growth in Nigeria. Second, the causal effect of economic growth on financial sector

development is as well found to be negatively insignificant in the long-run and negatively

significant in the short-run. Third, the causal effect of crude oil price on financial sector

development is found to be positive and significant in the long-run, suggesting that crude oil price

is the underlying factor that determines the amount of economic activities passing through the

Nigerian financial sector. The results highlight the need for a well-articulated policy framework

that will lessen the high dependence of the Nigerian economy on crude oil.

1. Introduction

The theoretical foundational study of Schumpeter (1911) presents financial sector

development as a key driver of long-term economic growth. Building on the study, a

number of more recent studies identified channels through which financial sector

development contributes to economic growth (Greenwood and Jovanovic, 1990;

Bencivenga and Smith, 1991; King and Levine, 1993; Levine, 1997, 2004, among

others). The first identified channel is concerned with the role of financial intermediaries

in the mobilization of savings and subsequent allocation of resources which affects the

degree of economic activities in the private sector. The second channel is related to the

role of financial intermediaries in creating economic conditions that enhance efficiency

in the allocation of resources. Levine (2004) identified these economic conditions that

enhance efficiency in resource allocation to include: reduction in information

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asymmetries and transaction costs, fund pooling, risk diversification, liquidity manage-

ment, screening and monitoring of firms. Conversely, Robinson (1952) shows that

economic growth will enhance financial sector development by increasing the level of

demand for financial intermediary services in the economy. Patrick (1966), however,

shows that financial sector development stimulates economic growth at earlier stages of

economic growth while economic growth promotes financial development at later stages.

Given that economic activities in oil-dependent economies are significantly

determined by oil resources rather than savings of various economic units (mainly

households), the degree with which economic activities is carried out through financial

intermediaries will be low, weakening the link between financial intermediary

development and economic growth (Nili and Rastad, 2007). Hence, crude oil price

may play a significant role in explaining financial sector development in oil-dependent

economies. Higher crude oil prices will therefore mean higher revenue and more

economic activities passing through the financial intermediary sector. On the other hand,

a lower crude oil price, will adversely impact on the activities of financial intermediaries.

The well-documented low-level of financial sector development in oil-dependent

economies has significantly been linked to activities in the oil sector in recent studies

(see Nili and Rastad, 2007; Beck, 2011; Barajas et al., 2013). This study is therefore

based on the influence of crude oil price on economic activities in developing oil-

exporting countries.

Figure 1 presents a hypothesised interaction among financial sector development,

economic growth and crude oil price. In this framework, crude oil price and financial

development may influence the level of economic growth and crude oil price, and

economic growth may determine the level of financial development. Among many

empirical studies that have examined the causal effects of crude oil price on economic

activities in oil-exporting countries, none has considered financial sector development. In

fact, literature on financial sector development in developing oil-exporting economies is

still scarce. The focus of most studies has been on the effects of crude oil price on

macroeconomic performance (see for instance Mehrara and Oskoui, 2007; Mehrara,

2008; Lescaroux and Mignon, 2008; Iwayemi and Fowowe, 2011; Omojolaibi, 2014;

Moshiri, 2015). Given the role of financial sector development in resource mobilisation

and allocation, it is important to empirically understand the interaction among these

variables as presented in Figure 1.

From the foregoing, this study raises three important questions. First, does financial

sector development stimulate economic growth in Nigeria? Only few studies have

attempted to answer this question. Adeniyi et al. (2015) examined the relationship

between financial sector development and economic growth in Nigeria from 1960 to

2010 using two indicators of financial sector intermediary development: the ratio of

liquid liabilities of the Nigerian financial sector to GDP and domestic credit provided to

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