Is there a link between economic growth and insurance and banking sector activities in the G‐20 countries?

• Author: Atul Gupta,Rudra P. Pradhan,Mak B. Arvin,Mahendhiran Nair,John H. Hall
• Published date: 01 April 2017
• Date: 01 April 2017
• DOI: http://doi.org/10.1016/j.rfe.2017.02.002

Is there a link between economic growth and insurance and banking

sector activities in the G-20 countries?

Rudra P. Pradhan

a,

⁎, Mak B. Arvin

b

,MahendhiranNair

c

,JohnH.Hall

d

, Atul Gupta

e

a

Vinod GuptaSchool of Management, IndianInstitute of Technology,Kharagpur 721302, India

b

Departmentof Economics, TrentUniversity, Peterborough,Ontario K9J 7B8,Canada

c

Schoolof Business, Monash UniversityMalaysia, JalanLagoon Selatan, 47500,Malaysia

d

Departmentof Financial Management,University of Pretoria,Pretoria 0028, South Africa

e

Schoolof Business and Economics, LynchburgCollege, Lynchburg,VA 24501, USA

abstractarticle info

Articlehistory:

Received20 March 2016

Receivedin revised form 11 September2016

Accepted14 February 2017

Availableonline 27 February 2017

Rapid technological developmentover the last three decades hasenabled different sectorsof the economy to be

seamlesslyintegrated.This has had an important spill-overimpact on the wealth of countriesacross the globe. In

thispaper we examine theinter-linkagesbetween the bankingsector and the insuranceindustry on the econom-

icgrowth of the G-20 countriesbetween 1980 and 2014.Using the vector auto-regressionmodeland the Granger

causalitytest, the study shows that inthe long run, developmentsin the banking sector and insuranceindustry

havehad a significant impact on theeconomic growth of the G-20countries. In the short term,the inter-relation-

ships betweenthe three factors prove to be more complex in thatthey differ by countries in differentstages of

development. Based on the empirical findings, this paper discusses the policies and strategies policy makers

and banksand insurance companiesshould have in place inorder to create sustainedeconomic growth in an in-

creasinglyinter-connected world.

© 2017 Elsevier Inc. All rights reserved.

Keywords:

Insurancemarket activities

Bankingsector activities

Economicgrowth

The G-20countries

1. Introduction

The globaleconomy has undergone unprecedented changeover the

last threedecades, in part poweredby rapid developmentsin and diffu-

sion of information and communication techn ology (ICT) across the

globe. These streams of ICT innovation s have enabled key sectors of

the economyand countriesacross the globe to be moreinter-connected

and inter-dependent on one another.One of the first economic sectors

that have embraced the digital revolution is the financialsector, which

consistof both the banking and insurancesectors. Seamless integration

of thesetwo industries poweredby the ICT revolutionhas enabled them

to createa stronger multipliereffect, as well as a higher degreeof econ-

omiesof scale and scope.Inter-connectivityof sectors andcountries also

pose theirown challenges in that,a shock or turbulencein one sector or

economy has the potential to reverberate acros s other sectors of the

economy andmay lead to a contagion effect.

The primaryobjective of this study is toascertain the inter-linkages

between the banking sector and the insurance industry over a period

exhibiting rapid ICT changes in the gl obal economy and to examine

the impact of these linkages on the ec onomic growth of the G-20

countries. Over the sample period, major reforms have taken placein

the G-20 countriesto develop the banking sector andinsurance indus-

try.Many of these countrieshave also undertakenmajor strategicdevel-

opment initiatives to modernise infrastructure (physical and digital)

and diversifytheir economies to raisethe standard of livingof their cit-

izens. This study will provide empirical evidence on whether the re-

forms undertaken in the banking sector and insurance industry have

had a deepening impact on economic gr owth (both in the long run

and short run)for the G-20 countries overthe sample period.

It is widely acknowledged that financial sector development is an

important catalystfor sustained economic growth for countries across

theglobe. There is an extantliterature thathas examined the linkagebe-

tween financial development and economic growth,using time series,

cross sectional, pooled, and panel data (Me nyah, Nazlioglu, &

Wolde-Rufael, 2014; Liu & Lee, 2014; Beck, Demirguc-Kunt, &

Maksimovic, 2005;Levine, 2003; Craigwell, Downes,& Howard, 2001;

Levine, Loayza, & Beck, 2000; Ahmed & A nsari, 1998; King & Levine,

1993a, 1993b; Pagano, 1993; Pr adhan, Bahmani & Kiran, 2014;

Yilmazkuday, 2011). These studies showa positive long-run relation-

ship between financial development

1

and economic growth. Most of

Reviewof Financial Economics 33 (2017)12–28

⁎Correspondingauthor.

E-mailaddresses: rudrap@vgsom.iitkgp.ernet.in(R.P. Pradhan),marvin@trentu.ca

(M.B. Arvin),mahendhiran.nair@monash.edu(M . Nair), john.hall@up.ac.za(J.H. Hall),

Gupta@Lynchburg.Edu(A. Gupta).

1

Theseinclude broad money supply,domestic credit to private sector,domestic credit

providedby banking sector,market capitalization,and soforth (see, for instance,Pradhan,

Dasgupta,& Samadhan, 2013).

http://dx.doi.org/10.1016/j.rfe.2017.02.002

1058-3300/©2017 Elsevier Inc. All rightsreserved.

Contents listsavailable at ScienceDirect

Review of Financial Economics

journal homepage: www.elsevier.com/locate/rfe

the resultsof these studies suggestthat a well-developed financialsys-

tem isgrowth-enhancing,and therefore consistentwith the proposition

of “more finance, moregrowth”(Law & Singh, 2014).

Financial development is commonly defined in terms of aggregate

size of the financial sector, its sectorial composition, and a range of

attributes of its individual sub-sectors that determine their effective-

ness in meeting the various economic agents' requirements to

enhance their wealth. Key financial institutionsinclude the central

bank, commercial bank s, merchant banks, saving institution s, mort-

gage entities, pension funds, stock markets, and other financial

market institutions (Zaman, Izhar, Khan, & Ahmad, 2012). Thus, finan-

cial development-growth linkage represents all activities undertaken

by the above-mentioned financial institutions and their lin kage with

economic growth (Levine, 2005).

While there is extensive research onfinancial sector development-

economicgrowth nexus, the existingliterature provides narrowcover-

age forthe insurance marketactivities andits association withboth eco-

nomic growth

2

and other financial services, particularly with banking

sector activities.

3

The obvious questionis why would one consider insurancemarket

activities and its possible link to economic growthand banking sector

activities?One of the primary roles of the insurance industryis to pro-

vide coverage against risks associatedwith natural calamities and un-

certain economic environment. Over th e last four decades natural

disasters and turbulent global economic en vironment have wreaked

havoc on the banking sector and have undermined economic growth

in many countries.Natural disasters tend to destroycritical infrastruc-

ture, human capabilities, production facilities and ‘crowd-out’key in-

vestments from economic and productive en deavours (Noy, 2009).

From 1970 to 2014, there have been close to 11,985 natural disasters

such as floods, storms, earthquakes, tsunamis, landslides, epide mics,

draught and other calamities, resulting in economic losses of USD2.8

trillion (in constant 2005 USD dollars)(ESCAP-United Nations, 2015).

People living in countries with la rge populations, such as China and

India,as well as other lessdeveloped countries,are less preparedto mit-

igate the economic risks associate to natural disasters (ESCAP-United

Nations, 2015).

Given the importance of managing risksassociated with natural di-

sasters and global economic uncertainties, the present study will ex-

plore whether a more active insuranc e industry will contribute to a

more active banking sector as well as to greater economic prosperity

through growth.Hence, the primary objective of this study is toexam-

ine the causalrelationships between insurancemarket activities,bank-

ing sector activities, and economicgrowth. The empirical investigation

will be conducted for the G-20 countries, which consists of seven ad-

vanced countries, twelve develop ing countries

4

and the European

Union. The G-20 countries account for 65% of the world's population

and close to 90% of world's gross domestic product (Fu, Turner, Zhao,

& Du, 2015; Yao,Feng, & Hubacek, 2015).

The results of the present study can be utilised in a number of

ways. Firstly, the importance of a more developedinsurance sector

will be highlighted for the policymakers in each of the G-20 coun-

tries. The importance of the insurance sector is underlined by the

fact that it relates directly to the economic growth (and therefore

prosperity) of a country. Secondly, the prominence of the insurance

sector within the econ omic system of a country should act as i ncen-

tive for the insurance sector itself to promote and enhance their ac-

tivities. Thirdly, the expansion of the financial sector could also

lead to an increase in the living standards of the general population

as more individuals can be integrated and become clients of the

banking sector and other financial institutions. Lastly, due to grow-

ing financial and insurance sectors, improvement in the living

standards of a country' s inhabitants and possible reduc tion in unem-

ployment levels could follow (though this will not be statistically

tested in the present study).

The remainder of the paper is organised as follows. In Section 2,a

briefreview of the literatureis provided. InSec tion 3 theinsurance mar-

ket activities and banking secto r activities in the G-20 countries are

discussed. Section 4 addresses the conceptualframework, proposedhy-

potheses,and the data. Section 5 outlinesthe proposed empiricalmodel

and the econometric estimationmethod used inthis study. In Section 6,

the empiricalresults are discussed. Section7 provides the policy impli-

cations and concluding remarks.

2. Literaturereview

The relationship between financia l development and economic

growth has been widely discussed in the literature (see, for instance,

Rousseau& Yilmazkuday, 2009;Rousseau & Wachtel, 2011).In general,

four perspectives have emergedin the literature pertaining to therela-

tionships between financial development

5

and economic growth. The

first perspective is known as the “Supply-Leading Hypothesis”(SLH),

which postulates that economicgrowth follows financial develop ment.

According SLH, increased savings and improved efficiency of inves t-

ment (more generally, financial dev elopment) leads to economic

growth (McKinnon, 1973).

The second perspective is known as the “Demand-Following

Hypothesis”(DFH), which postulates that financial development

follows economic growth. According to this approach, as the real

side of the economy expands, the demand for financial services

increases, leading to the growth for financial services (Robinson,

1952).

The third perspective to the relationship between financial

development and economic growth is the “Feedback Hypothesis”

(FBH), which suggest s the presence of both SLH and DFH; that is, fi-

nancial development contributes to economic growth and as the

economy grows, it r einforces the demand for more sop histicated fi-

nancial services. This interaction between financial development

and economic growth enhance the reach and richness of the financial

sector.

The fourth perspective to characterising the dynamics between

financial development and economic growth is the “Neutrality

Hypothesis”(NEH), which postulates that both financial develop-

ment and economic growth are independent of each other; that is,

they do not have a significant impact on each other. The studies

support these four hypotheses are highlighted in Al-Yousif

(2002),Mukhopadhyay, Pradhan, and Feridun (2011),Pradhan,

Mukhopadhyay, Gunashekar, Bele, and Pandey (2013) and

Samargandi, Fidrmuc, and Ghosh (2015).

As discussed above, considerable number of studies has

examined the dynamics between a broad measure of financial

development and economic development. The present study is

strictly devoted to highlighting the literature relating to the nexus

between insurance market development and economic growth

nexus, as well as the banking sector development and economic

growth nexus.

2

The relationships between insurance market activities and economic growth have

been studiesby Lee, Lee, and Chiu (2013),Horng,Chang, and Wu (2012),Chen, Lee,and

Lee (2012),Adams, Andersso n, Andersson, and Lindmark (2009),Curak, Lo ncar, and

Poposki(2009),Arena (2008),Haissand Sumegi (2008),andBoon(2005) inter alia.

3

Theinsurance market linkwith banking sector and economicgrowth for one country,

namelySweden, has been studied by Adams et al.,2009.

4

The advancedcountries in G-20 areCanada, France, Germany,Italy, Japan, the United

Kingdom,and the United States.The emerging economiesare Argentina, Australia,Brazil,

China,India, Indonesia, Mexico,the Russian Federation,Saudi Arabia, South Africa,South

Korea,and Turkey.

5

Financial developmentmay also be interpreted as stock market development, bond

market development,and so forth; but stock market and bond market activities arenot

consideredhere due to our specificconcern with regardsto banking sector and insurance

marketactivities.

13R.P. Pradhanet al. / Review of FinancialEconomics 33 (2017)12–28