A report writing on

The Impact of Financial Development and Trade Openness On

The Economic Growth of Bangladesh

Bangladesh University of Business & Technology (BUBT)

PREPARED BY
Sabiha Akter
ID: 16171106007
Intake: 25th
Program B.Sc. in Economics
Bangladesh University of Business & Technology (BUBT)

SUPERVISED BY
Tahmina Akhter
Assistant Professor
Department of Economics
Bangladesh University of Business & Technology (BUBT)

Date of submission:
Bangladesh University of Business & Technology (BUBT)

1
 Declaration
I do thereby declare that this dissertation title “ The Impact of Financial Development and Trade
Openness On the Economic Growth of Bangladesh’’ submitted to the Department of Economics,
Bangladesh University of Business & Technology(BUBT), is a report writing done under the
supervision of Tahmina Akhter, Assistant professor, Department of Economics , Bangladesh
University of Business & Technology(BUBT). I also declare that the data and information used
for the dissertation are true & original.

Supervisor

Sabiha Akter
ID: 16171106007
Intake: 25th
Program B.Sc. in Economics
Bangladesh University of Business & Technology (BUBT)

2
 Letter of Endowment
This is certify that Sabiha Akter, student of B. Sc Economics ,25th intake, ID- 16171106007, has
completed the report writing on “The Impact of Financial Development and Trade Openness On
the Economic Growth of Bangladesh’’ The report has been organized under my direction &
record of truthful work.

Supervisor

Tahmina Akhter
Assistant professor
Department of Economics
Bangladesh University of Business & Technology (BUBT)

3
 Acknowledgement
At first, I express my profound gratefulness to the Almighty creator. I am deeply beholden to my
supervisor, Mrs. Tahmina Akhter, Assistant professor, Department of Economics, Bangladesh
University of Business & Technology (BUBT), who has given me the opportunity to do this
study. Her continuous administration & advice has helped me to find out the right way to find the
materials & complete this work. I appreciate her constant & valuable support during the course
of my report writing. Without her devotion this report writing could not have been a
comprehensive one.
Lastly, I would like to state my thanks to teachers and researchers, whose books & articles I
review & friends who helped me in every stages of the report by giving their valuable
information & idea in administration of preparing this reprt.

4
Contents
Declaration..................................................................................................................................................2
Letter of Endowment...................................................................................................................................3
Acknowledgement.......................................................................................................................................4
Abstract.......................................................................................................................................................6
Chapter 1: Introduction...............................................................................................................................7
1.1 Introduction.......................................................................................................................................7
1.2 The objective of study.....................................................................................................................10
Chapter 2: Theoretical and empirical literature review.............................................................................11
2.1 Theoretical literature review...........................................................................................................11
2.2 Empirical literature review..............................................................................................................12
Chapter 3: Methodology...........................................................................................................................16
3.1 Description of variables:..................................................................................................................16
3.2 Unit root test...................................................................................................................................17
3.3 Co-integration test:..........................................................................................................................18
Chapter 4: Result analysis..........................................................................................................................20
Chapter 5: Conclusion and policy implication:...........................................................................................23
Chapter 6: References...............................................................................................................................24

5
 Abstract
The purpose of this study is to investigate the impact of financial development and trade openness on
economic growth of Bangladesh for the period 1975-2019. The study employs two analytical tool for
investigation. At first the Augmented Dickey Fuller unit root test have been applied to examine the
stationarity properties of the series. Secondly, the Johansen cointegration approach is also used to find out
the long run relationship among the variables. Finally the data was tested for normalized cointegration
coefficient.
The empirical results demonstrate that in the in the long run financial development and trade openness is
positively related economic growth.

6
 Chapter 1: Introduction

1.1 Introduction

The economy of Bangladesh is a developing market economy. It's the 39th largest in the world in
nominal terms, and 30th largest by purchasing power parity; it is classified among the Next
Eleven emerging market middle income economies and a frontier market. In the first quarter of
2019, Bangladesh's was the world's seventh fastest-growing economy with a rate of 7.3% real
GDP annual growth. (Wikipedia, 2020).

Financial development is part of the private sector development strategy to stimulate economic
growth and reduce poverty. Financial development means some improvements in producing
information about possible investments and allocating capital, monitoring firms, and exerting
corporate governance, trading, diversification, and management of risk, mobilization, and
pooling of savings, easing the exchange of goods and services. These financial functions affect
savings and investment decisions, and technological innovations and hence economic growth.
(Igiglobal.com,2020)

The general concept of financial development refers to the enhancement and base of financial
instruments which are economically accessible in a country whereas financial growth refers to
the changes in financial system in terms of its size and structure. In other words, financial growth
means the development of financial markets (Erim and Turk, 2005).

Financial development increase economic growth by raising: (i) The ratio of saving to gross
domestic product; (ii) The proportion of saving channeled to investment and (iii) The marginal
productivity of capital, (iv) Hedging, facilate the trading, and pooling of risk, (v) Allocate
resources.

Financial sector is the set of institutions, instruments, markets, as well as the legal and regulatory
framework that permit transactions to be made by extending credit. Fundamentally, financial
sector development is about overcoming “costs” incurred in the financial system. This process of
reducing the costs of acquiring information, enforcing contracts, and making transactions
resulted in the emergence of financial contracts, markets, and intermediaries. Different types and
7
combinations of information, enforcement, and transaction costs in conjunction with different
legal, regulatory, and tax systems have motivated distinct financial contracts, markets, and
intermediaries across countries and throughout history.

The five key functions of a financial system are: (i) producing information ex ante about possible
investments and allocate capital; (ii) monitoring investments and exerting corporate governance
after providing finance; (iii) facilitating the trading, diversification, and management of risk; (iv)
mobilizing and pooling savings; and (v) easing the exchange of goods and services.

A large body of evidence suggests that financial sector development plays a huge role in
economic development. It promotes economic growth through capital accumulation and
technological progress by increasing the savings rate, mobilizing and pooling savings, producing
information about investment, facilitating and encouraging the inflows of foreign capital, as well
as optimizing the allocation of capital. Countries with better-developed financial systems tend to
grow faster over long periods of time, and a large body of evidence suggests that this effect is
causal: financial development is not simply an outcome of economic growth; it contributes to
this growth.

Additionally, it reduces poverty and inequality by broadening access to finance to the poor and
vulnerable groups, facilitating risk management by reducing their vulnerability to shocks, and
increasing investment and productivity that result in higher income generation. Financial sector
development can help with the growth of small and medium sized enterprises (SMEs) by
providing them with access to finance. SMEs are typically labor intensive and create more jobs
than do large firms. They play a major role in economic development particularly in emerging
economies.

A good measurement of financial development is crucial to assess the development of the

financial sector and understand the impact of financial development on economic growth and
poverty reduction. In practice, however, it is difficult to measure financial development as it is a
vast concept and has several dimensions. Empirical work done so far is usually based on
standard quantitative indicators available for a long time series for a broad range of countries.
For instance, ratio of financial institutions’ assets to GDP, ratio of liquid liabilities to GDP, and
ratio of deposits to GDP. Nevertheless, as the financial sector of a country comprises a variety of

8
financial institutions, markets, and products, these measures are rough estimation and do not
capture all aspects of financial development. (The World Bank, 2020)

GDP per capita acts as a metric for determining a country's economic output per each person
living there. Often times, rich nations with smaller populations tend to have higher per capita
GDP. Once you do the math, the wealth is spread among fewer people, which raises a country's
GDP. The fact that the GDP per capita divides a country's economic output by its total
population makes it a good measurement of a country's standard of living, especially since it tells
you how prosperous a country feels to each of its citizens

The formula is GDP divided by population or GDP/Population. If you’re looking at just one
point in time in one country, then you can use regular, “nominal” GDP divided by the current
population. “Nominal” means GDP per capita is measured in current dollars. If you want to
compare GDP per capita between countries, you must use purchasing power parity. That creates
parity, or equality, between economies by comparing a basket of similar goods. It's a
complicated formula that values a country's currency by what it can buy in that country, not just
by its value as measured by its exchange rates. (The balance.com, 2020).

Trade is an engine of growth that creates jobs, reduces poverty and increases economic
opportunity. Over one billion people have moved out of poverty because of economic growth
underpinned by open trade since 1990. The World Bank Group supports an open, rules-based,
predictable, international trading system.

Open trade brings important, often overlooked benefits to lower-income households by offering
consumers more affordable goods and services. For the extreme poor, trade can help reduce the
prices of food. For women, trade can create jobs and increase incentives for girls to stay in
school.

Developing countries often struggle with indirect factors that hinder their access to global
markets, such as anti-competitive business practices, regulatory environments that are
unfavorable to business growth and investment, or limited infrastructure capacity. Even a
country with liberal and transparent trade policy suffers if its markets are not connected, and
many of the world’s poorest people live in places that are landlocked, remote, or otherwise ill-
served by international trade links. The World Bank Group helps its client countries improve

9
their access to developed country markets and enhance their participation in the world economy
by overcoming these obstacles.

Despite the benefits trade can bring to economies, not everyone is experiencing the benefits of
globalization. Trade, with the productivity gains and technological advances that accompany it,
can result in job losses in certain regions and industries. It is tried to working to advance policies
that help all countries benefit from the opportunities that come with trade and technological
change. These include short-term responses such as training programs and job search assistance,
but also long-term solutions that build more resilient economies. Strong safety nets, access to
education that prepares students for the jobs of the future, and policies that help workers become
more mobile are all critical to these solutions.

The world needs to strengthen the global trading system to promote greater inclusiveness and
help developing countries address trade-related constraints to growth. The system of global trade
rules that has nurtured unprecedented economic growth across multiple generations faces
tensions. These tensions should not prevent us from looking at the unique untapped benefits
further trade reform can bring to the global economy. (The World Bank, 2020).

Bangladesh has been able to maintain a strong position in the export sector. In the first eight
months of the FY2018-19, both the export earnings and the import expenditure have increased in
comparison to the same period in the previous fiscal year. During the July-February of FY2018-
19, the total export earnings increased by 12.98 percent to US$27,563 million compared to the
same period in the previous fiscal year. A notable contribution of ready-made garments and
knitwear products to the country's total export revenues has also been continuing in FY2018-19.
On the contrary, imports rose by 5.6 percent to US$40,895 million in the first eight months of the
same fiscal year. (Bangladesh Economic Review 2019).

1.2 The objective of study

To find out -

I. The Impact of Financial Development and Trade Openness on Economic Growth of

Bangladesh.

10
 Chapter 2: Theoretical and empirical literature review
2.1 Theoretical literature review

Three types of opinions are available in the theoretical literature on financial and economic
growth association. First, in his pioneering study, Schumpeter (1911) identified positive effect of
financial development on productivity and economic growth. He stated that financial
intermediaries play a central role in the enhancement of technological transformation and
economic development by offering essential services such as, channeling the savings towards
productive investment. The second view states that finance is relatively less important for
economic growth. Robinson (1952) pointed out that financial development does not cause
economic growth. Instead economic growth leads to financial development. Lucas (1988) stated
that physical capital, human capital and technological change are the only factors that influence
economic growth. The third opinion argues that financial development exerts negative impact on
economic growth. Van Wijnbergen (1982) and Buffie (1984) stated that financial developments
can have none or a negative impact on economic growth. Singh (1997) suggested that financial
development impedes economic growth when it induces instability and discourages risk-averse
investors from investing. (Adnan & Islam 2013)
In the 1970s McKinnon and Shaw developed a theoretical framework that helped to
explain growth-inducing effects of financial liberalization in contrast to financial repression.
They argued that the financial sector could raise the volume of savings as well as the quantity
and quality of investment.
The Mckinnon–Shaw school examines the impact of government intervention on the
development of the financial system. Their main proposition is that government restrictions on
the banking system, such as interest rate ceilings and direct credit programmes have negative
effects on the development of the financial sector and, consequently, reduce economic growth
(Mckinnon, 1973; Shaw, 1973).
In this paper used two tests first one is Augmented Dickey Fuller test (ADF) and second one is a
Johansen cointegration Test. At first the data was tested for stationarity using Augmented Dickey
Fuller test (ADF) which was found to be stationary at first difference. Secondly the Johansen test

11
statistics show rejection for the null hypothesis of no co integrating vectors under both the trace
and maximum Eigen value form of the test.

2.2 Empirical literature review

Khan & Qayyum (2007) investigated the impact of trade and financial liberalization on
economic growth in Pakistan using annual observations over the period 1961-2005. The analysis
is based on the bound testing approach of cointegration advanced by Pesaran, et al. (2001). The
empirical findings suggest that both trade and financial policies play an important role in
enhancing economic growth in Pakistan in the long-run. However, the short-run responses of the
real deposit rate and trade policy variables are very low, suggesting a further acceleration of the
reform process. The feedback coefficient suggests a very slow rate of adjustment towards long-
run equilibrium. The estimated equation remains stable throughout the study as indicated by
CUSUM and CUSUMQ stability tests..

Gupta et al. (2007) revealed that there is a long-run equilibrium relationship between financial
development, international trade, and real income growth in the case of India. Furthermore,
unidirectional causality was investigated that runs from real income to exports and imports, from
exports to imports, M2 and domestic credits, from M2 to imports, from imports to domestic
credits. Bidirectional causality has also been obtained between real income and M2, and between
real income and domestic credits. Finally, no direction of causality has been obtained between
M2 and domestic credits.

Omoke (2009) examined the causal relationship among financial development, trade openness,
and Economic Growth in Nigeria for the period 1970-2005. The econometric methodology
employed was the Cointegration and Granger Causality test. The stationarity properties of the
data and the order of integration of the data were tested using both the Augmented Dickey-Fuller
(ADF) test and the Phillip-Perron (PP) test. The variables tested stationary at first differences.
The Johansen multivariate approach to cointegration was applied to test for the long-run
relationship among the variables but there were no cointegrating relations between Growth, trade
openness, and the three measures of financial development (Direct Credit, Private Credit, and
Money supply). The Granger-causality empirical findings suggest that trade openness and

12
financial development do have a causal impact on economic growth; conversely, growth has a
causal impact on trade and financial development, implying support for growth-led trade but no
support for trade-led growth. Domestic credit, Private credit, and broad money, as percentages of
GDP, showed no causal impact on economic growth rather economic growth was seen to
necessitate these credits and the supply of money. Also, the Money supply was the only
instrument of financial development that was seen to cause Trade openness.Yucel (2009)
examined the causal relationship between financial development, trade openness, and economic
growth (GDP) for the Turkish economy. In time series context, recently developed econometric
techniques were used: namely the Augmented Dickey-Fuller (ADF) for unit root, Johansen and
Juselius (JJ) for cointegration and Granger causality test for causal relationships. The findings of
the study showed that while trade openness has a positive effect, financial development has a
negative effect on growth. Moreover, the Granger causality test results revealed the presence of a
bicausal relationship between financial development, trade openness, and growth indicating that
economic policies aimed at financial development and trade openness have a statistically
significant impact on economic growth.

Atif et al. (2010) found that the impact of financial development and trade openness on GDP
growth in Pakistan using annual data over the period 1980-2009. The analysis is based on the
bound testing approach of co-integration advanced by Pesaran et al (2001). The empirical results
confirm the validity of the trade-led growth and finance-led growth hypothesis in Pakistan. A co-
integrated relationship between economic growth, trade openness, and financial development
was noticed in both the long-run and short-runs. Further analysis showed that trade openness and
financial development Granger-cause economic growth in the period of study.

Gries et al. (2011) investigated the causal interactions between financial deepening, trade
openness, and economic growth in 13 Latin American and Caribbean countries. It is tried to
construct a composite indicator for financial deepening and use it to detect Granger causality
within a modified Vector Autoregressive/Vector Error Correction Model (VAR/VECM)
framework. It is tried to find almost no evidence for the popular hypothesis of finance-led
growth. Evidence of bidirectional finance–growth causality is stronger but mostly unstable in the
long run. Most results indicate a demand following or insignificant causal relationship between
finance and growth. There is also no evidence that finance indirectly induces growth via the

13
channel of trade openness. Hence, policies that prioritize financial and trade sector development
cannot be supported.Bojanic (2012) showed that the relationship of economic growth with
financial development and trade openness was analyzed with annual time-series data for Bolivia
during the 1940–2010 period. The analysis was an advance over previous work in several ways.
First, the hypothesis of a long-run relationship between these variables was tested using bivariate
cointegrated systems and employing the methodology of cointegration analysis. Second,
causality tests utilizing standard Granger regressions and ECM models are carried out to
determine the direction of causality between indicators of economic growth and financial
development, and economic growth and trade openness. Lastly, the study comprises a period of
seventy years, a first for a study of this kind on Bolivia. The empirical results demonstrated that
there was indeed a long-run equilibrium relationship and that unidirectional Granger causality
runs from the indicators of financial development and trade openness to economic growth.

Asghar & Hussain (2014) showed that the causal relationship between financial development and
economic growth in developing countries throughout 1978-2012. The study empirically explores
the channels through which financial development may influence economic growth more
specifically in the context of Foreign Direct Investment (FDI) and trade openness. The financial
development index is constructed and panel cointegration tests are applied to check the existence
of a long-run relationship between the variables of interest. The findings of the study show that
there is strong evidence of the long-run relationship between financial development and
economic growth in developing countries. There exists bi-directional causation between financial
development and FDI. Furthermore, trade openness has an impact on financial development in
all the countries, which calls for the introduction of effective policy measures to promote trade
between countries.

Kar et al. (2014) analyzed the causality among trade liberalization, financial development, and
economic growth in Turkey. By employing monthly data for the period January 1989- November
2007, both linear and nonlinear causality approaches indicate that (i) there is bi-directional
causality between economic growth and trade openness, (ii) economic growth causes financial
development, and (iii) financial development leads to trade liberalization. Thereby, linear and
nonlinear approaches confirm strong causal linkages among financial development, trade
openness, and economic growth in Turkey. These results partially imply that economic growth

14
depends upon trade liberalization through external finance in Turkey which has been
experiencing capital account liberalization since 1989.

Kaushal & Pathak (2015) analyzed that the causal relationship between Trade Openness,
Financial Development, and Economic Growth in India for the post-liberalization period ranging
from 1991-2013. The paper uses Vector auto-regression and Granger Causality test as an
econometric methodology for empirical findings. The empirical findings indicate that the growth
of a nation that is developing as in the case of India leads to Trade Openness (export and import).
Growth is also seen as a significant factor to impact private credit which in turn is seen to cause
Trade Openness. Financial Development (Private credit and money supply) has a causal impact
on Trade Openness by effectively allocating resources to promote productivity growth along
with technological upgradation. Hence the findings support the philosophy of growth led to the
trade. The neoclassical growth model attributes technological change as the cause of growth
which is possible with the wisely crafted economic policies like FDI in various sectors of the
country and India seems to be pretty active on this front.

Gokmenoglu et al. (2015) investigated the relationship between international trade, financial
development, and economic growth in Pakistan. The ADF and PP tests are used to check the
order of integration of the variables and Johansen co-integration methodology is employed to
investigate the long-run relationship among these variables. The direction of causality between
variables is tested by the Granger causality test. It is found that all of the variables are non-
stationary and the analysis confirms for a long-run relationship among international trade,
financial development, and economic growth. The results indicate that international trade and
financial development spur economic growth in Pakistan.

15
 Chapter 3: Methodology

In this paper, the annul data of GDP, Financial development, Trade openness, has been taken
from the World Development Indicators, covering the period 1975-2019 for Bangladesh.

3.1 Description of variables:

(a) Trade openness (TO)

Trade openness is one measure of the extent to which a country is engaged in the global trading
system. Trade openness is usually measured by the ratio between the sum of exports and imports
and gross domestic product (GDP).The formula for calculating trade openness is given below:

Exports+ Imports
Trade openness =
GDP

(b) Financial development (FD)

Financial development means some improvements in producing information about possible

investments and allocating capital monitoring firms and exerting corporate governance, trading,
diversification and management of risk, mobilization and pooling of savings, easing the
exchange of goods and services. These financial functions affect savings and investment
decisions and technological innovations and hence economic growth. The following formula is
used for calculating financial development:

Bank ' s Private Credit

Financial Development =
GDP

Model Specification

The following model is used to demonstrate the causal relationship between Trade Openness,
Financial Development and Economic Growth in Bangladesh.

GRt = α0+ α1 FDt + α2 TOt +Ɛt…………….. (1)

Where:

16
FD is Financial Development Proxied by Private Credit (PC).

GR = Growth rate measured by real per capita GDP

TO= Trade Openness

α0, α1, α2 = constant term

t = time trend, and

Ɛ= random error term

Financial Development is being proxied by One variable hence there is One model to separate it
and determine of these variable with GR and TO.

Model:

GRt = β0 + β1 PCt+ β2 TOt + Ɛ2t

3.2 Unit root test

The co-integration test between the examined variables requires initially a test for the existence
of a unit root for each individual time series and especially for financial development, economic
growth and the degree of openness. Thus, the integration order of variables will be verified, since
the causality tests are valid, whether the variables have the same integration order.

Many macroeconomic time series contain unit roots dominated by stochastic trends as developed
by Nelson & Plosser (1982). Unit roots are important in examining the stationarity of a time
series because a non-stationary regressor invalidates many standard empirical results. The
presence of a stochastic trend is determined by testing the presence of unit roots in time series
data. A unit root test is performed using Augmented Dickey–Fuller (ADF) (Dickey & Fuller,
1979) or that of Kwiatkowski et al. (1992) – see Table 1.

Augmented Dickey–Fuller (ADF) Test

The Augmented Dickey–Fuller (ADF) test refers to the t-statistic of _2 coefficient on the
following regression:

17
 k
∆ X t = δ 0 + δ 1t + δ 2Xt-1 + ∑ α i∆ Xt=1+Ut ………………….(2)
i=1

The ADF regression tests for the existence of unit root of Xt, namely in the logarithm of all
model variables at time t. The variable ∆ Xt-i expresses the first differences with k lags, and
finally ut is the variable that adjusts the errors of autocorrelation. The coefficients δ 0, δ 1, δ 2, and
α i are being estimated. The null and the alternative hypothesis for the existence of unit
root in variable Xt is:

H0:δ 2=0 HƐ:δ 2<0

This paper follows Engle & Yoo (1987) by using the Akaike information criterion (AIC)
(Akaike, 1974), to determine the optimal specification of equation (2).

3.3 Co-integration test:

The second stage involves testing for the existence of any long-run relationship between per
capita GDP, financial development, and trade openness. Stock and Watson’s (1988) observation
that co-integrated variables share common stochastic trends provides a very useful way to
understand co-integration relationships (Enders, 2004). If the variables are co-integrated, then
there is a valid relationship and any divergence from a stable equilibrium state must be
stochastically bounded (Banerjee et al., 1993). A necessary condition for integration, however, is
that the data series for each variable exhibited similar statistical properties, that is, they were
integrated to the same order with evidence of some linear contribution of the integrated series.

In order to examine the co-integration test is possible if the variable of time series analysis
should have must be integrated in the same order & to the existence of a stable long-run
relationship between financial development, trade openness, and economic growth. For testing
the co-integration it is tried to use Engle–Granger (EG) or Augmented Engle–Granger (AEG)
Test.

18
To verify co-integrated relationship among the variables, Johansen Co-integration test (Johansen,
1988; Johansen and Juselius, 1990) unlike the Engle–granger, has been performed only on
integrated of order one, i.e. Johansen and Juselius (1990) specify two likelihood ratio test
statistics to test for the number of co-integrating vectors. Critical values for both test statistics are
tabulated by Johansen and Juselius (1990). Trace test and Maximum eigen value test statistic
equations are given below.

λmax= -t ln(1-λr+1)…………………………..1

λtrace=t∑ᵐ ᵢ‗ᵣ₋₁ ln (1- λᵢ)…………………….2

The first likelihood ratio statistic for the null hypothesis of exactly r co-integrating vectors
against the alternative r+1 vector is the maximum Eigen value statistic. The second statistic for
the hypothesis of at most r co-integrating vectors against the alternative is the trace statistic. Both
two tests (max& trace) possess nonstandard distribution under the null hypothesis that provides
nearly resembling critical values for the statistic exhibit Monte Carlo methods. The alternative
hypothesis of trace test requires that the co-integrating vector is either equal or less than r+1,
whereas r+1 is hold for the maximum eigen value test. For carrying out Johansen it is tried to
replaced per capita GDP to ln GDP, Financial development to ln FD, Trade to ln Trade.

19
 Chapter 4: Result analysis

The result of unit root test based on both the Augmented Dickey Fuller (ADF) demonstrates the
levels ,first difference and second difference of the individual variables.

TABLE 1. ADF test on economic growth, private credit and trade openness (Bangladesh: 1975-
2019)
Variables Augmented Dickey Fuller Augmented Dickey Fuller order of
( Intercept) (Trend and Intercept) Integration
Level 1st Diff. Level 1st Diff.
ln L_EG 9.151560 -3.085844*** 1.679211 -6.960990*** I(1)
***
ln L_PC -3.574402 -8.912030 -3.830707 -9.530326*** I(1)
ln L_TO -0.817387 -7.287643*** -2.390738 -7.174155*** I(1)
Notes: ***, ** and * indicate rejection of the null (variables are unit root/ non stationary) at the 1%, 5% and 10%
level respectively

The results of unit root test, ADF, indicate that at first differences of the variables economic
growth (ln L_EG), private credit (ln L_PC) and trade openness (ln L_TO) are statistically
significant at 1% significance level. Since, first degree differentiation produces stationarity, the
variables – L_EG (ln economic growth), L_PC (ln private credit), L_TO. (ln trade openness)
are integrated of order one - I(1). Since the variables are integrated of order 1, i.e. I(1), now this
paper can use the tests whether they are cointegrated or not (Table 3). The Johansen test statistics
show rejection for the null hypothesis of no co-integrating vectors under both the trace and
maximal Eigen value forms of the test.

Unrestricted Johansen Cointegration Rank Test ( Trace)

20
 Table: 2 Output for Eigen Value Test and Trace Statistics (Bangladesh: 1975- 2019)
Hypothesized Eigenvalue Trace Statistic 0.05 Critical Value P-value
No. of CE(s)
None * 0.623428  49.16210  29.79707  0.0001

At most 1  0.176078 8.142950 15.49471  0.4502

At most 2  0.000200  0.008404 3.841466  0.9266

Trace test indicates 1 co integrating eqn(s) at the 0.05 level

* denotes rejection of the hypothesis at the 0.05 level
**MacKinnon-Haug-Michelis (1999) p-values

In case of the trace test, the null of no co-integrating vectors is rejected since the trace statistic of
49.16210 is greater than the 5% critical value of 29.79707. Moving on to test the null of at most
1 co-integrating vectors, the trace statistic is 8.142950, which is less than 5%critical value of
15.49471.so that the null hypothesis of the existence of at most 1 co-integrating vectors is not
rejected at 5%. Moving on to test the null of at most 2 co-integrating vectors, the trace statistic is
0.008404, while the 5% critical value is 3.841466, so the null hypothesis is not rejected at 5%.
Finally, here from this table it is tried to say the above results indicate the existence of at least
one cointegrating equation among the variables in the series.

Table 3. Unrestricted Cointegration Rank Test (Maximum Eigen value)

Hypothesized Eigenvalue Max-Eigen .05 Critical Value P- Value

No. of CE(s) Statistics
None * 0.623428 41.01915 21.13162 0.0000
At most 1 0.176078 8.134547  14.26460  0.3652
At most 2 0.000200 0.008404 3.841466  0.9266
Max-eigenvalue test indicates 1 co integrating eqn(s) at the 0.05 level
 * denotes rejection of the hypothesis at the 0.05 level
 **MacKinnon-Haug-Michelis (1999) p-values
In case of the maximum eigenvalue test statistic, the null of no co-integrating vectors is rejected
since the maximum eigenvalue statistic of 41.01915 is greater than the 5% critical value
of 21.13162. Moving on to test the null of at most 1 co-integrating vectors, the maximum
eigenvalue statistic is 8.134547, while the 5% critical value is 14.26460, so that the null
hypothesis is not rejected at 5%. Moving on to test the null of at most 2 co-integrating vectors,

21
the maximum eigenvalue statistic is 0.008404, while the 5% critical value is 3.841466, so the
null hypothesis is not rejected at 5%. Finally, the max-eigenvalue test results indicate the
existence of at least one cointegrating equations among the variables in the series at 0.05 level.

Table-4 shows the values of the normalized cointegrating coefficients

Long-run impact of Private Credit and Trade Openness on Economic Growth of Bangladesh
(1975 – 2019)

Variables Normalized Standard Error Prob

cointegrating
coefficients
ln L_PC -0.270573 0.049210 0.0000
ln L_TO -0.55594 0.107708 0.0000

The values of the normalized cointegrating coefficients indicate that in the long run trade
openness and private credit is positively related to economic growth.

According to the above normalized equation, there exist a positive and significant long run
relationship among trade openness, private credit and economic growth in Bangladesh,which
indicates that over times with the increase of private credit and trade openness,economic growth
will also be increased.

22
 Chapter 5: Conclusion and policy implication:
This study analyzes the impact of trade openness and financial development on the economic
growth of Bangladesh for the period 1975-2019.At first the data was tested for stationarity using
Augmented Dickey Fuller test (ADF) which was found to be stationary at first difference.
Secondly the Johansen test statistics show rejection for the null hypothesis of no co integrating
vectors under both the trace and maximum Eigen value form of the test. The result of both trace
statistic and maximum Eigen value statistics indicate the existence of at least one cointegrating
equation among the variables in the series. The data was further tested for normalized
cointegrating coeffieicents. The results show that in the long run private credit and trade
openness is positively related to economic growth. A 1% increase in private credit and trade
openness increase economic growth by 27% and 4.9% respectively in the long run.

The findings of the study indicate that financial development and trade openness have a positive
impact on economic growth of Bangladesh. The contribution of financial development to
economic growth is considerable. It may therefore be recommended that policy makers place
special emphasis on implementing policies that result in the deepening of financial markets,
including institutional and legal measures to strengthen creditor and investor rights and contract
enforcement. Thus, by fostering the development of a country’s financial sector, economic
growth will be accelerated.

23
 Chapter 6: References

1. Adnan Hye, Q. M., & Islam, F. (2013). Does financial development hamper economic
growth: empirical evidence from Bangladesh. Journal of Business Economics and
Management, 14(3), 558-582.
2. Amadeo, K. 2020. What is per capita GDP. (https://www.thebalance.com/gdp-per-capita-
formula-u-s-compared-to-highest-and-lowest-3305848)Kim DH, Lin SC, Suen YB.
Dynamic effects of trade openness on financial development. Econ Modell
2010;27(1):254e61.
3. Asghar, N., & Hussain, Z. (2014). Financial development, trade openness and economic
growth in developing countries: Recent evidence from panel data. Pakistan Economic and
Social Review, 99-126.Erim, N. and A. Turk, 2005. Financial development and economic
growth. Kocaeli University Institute of Social Sciences Journal, 10: 21-45.
4. Atif, R. M., Jadoon, A., Zaman, K., Ismail, A., & Seemab, R. (2010). Trade
liberalization, financial development and economic growth: Evidence from Pakistan
(1980–2009). Journal of International Academic Research, 10(2), 30-37.Beck T, Levine
R, Loayza N. Finance and the sources of growth. J Financ Econ 2000;58(1e2):261e300.

5. Beck T, Levine R, Loayza N. Finance and the sources of growth. J Financ Econ
2000;58(1e2):261e300.Wikipedia,2020. Economy of Bangladesh.
(https://en.wikipedia.org/wiki/Economy_of_Bangladesh).

6. Beck T. Financial development and international trade: is there a link? J Int Econ
2002;57:107e31.

7. Bojanic, A. N. (2012). The impact of financial development and trade on the economic
growth of Bolivia. Journal of Applied Economics, 15(1), 51-70.
8. Dritsakis, N., & Adamopoulos, A. (2004). Financial development and economic growth
in Greece: An empirical investigation with Granger causality analysis. International
Economic Journal, 18(4), 547-559.

24
9. Erim, N. and A. Turk, 2005. Financial development and economic growth. Kocaeli
University Institute of Social Sciences Journal, 10: 21-45..

10. Gupta, A. D., Katircioglu, S. T., Kahyalar, N., & Benar, H. (2007). Financial
development, trade and growth triangle: the case of India. International Journal of Social
Economics..

11. Gries, T., Kraft, M., & Meierrieks, D. (2011). Financial deepening, trade openness and
economic growth in Latin America and the Caribbean. Applied Economics, 43(30), 4729-
4739.

12. Gokmenoglu, K. K., Amin, M. Y., & Taspinar, N. (2015). The relationship among
international trade, financial development and economic growth: The case of Pakistan.
Procedia Economics and Finance, 25(1), 489-496.

13. Igiglobal.com,2020. What is Financial Development. (https://www.igi-

global.com/dictionary/the-relationship-between-financial development-innovation-and-
economic-growth/47244).

14. Kaushal, L. A., & Pathak, N. (2015). The causal relationship among economic growth,
financial development and trade openness in Indian economy. International Journal of
Economic Perspectives, 9(2), 5-22.
15. Kar, M., Nazlioğlu, Ş., & AĞIR, H. (2014). Trade openness, financial development and
economic growth in Turkey: Linear and nonlinear causality analysis. Journal of BRSA
Banking & Financial Markets, 8(1).

16. Kaushal, L. A., & Pathak, N. (2015). The causal relationship among economic growth,
financial development and trade openness in Indian economy. International Journal of
Economic Perspectives, 9(2), 5-22.

25
17. Khan, M. A., & Qayyum, A. (2007). Trade liberalisation, financial development and
economic growth (No. 2007: 19). Pakistan Institute of Development Economics.

18. Levchenko AA. Trade and financial development. World Bank working paper series
3347. 2004 [April].

19. Menyah, K., Nazlioglu, S., & Wolde-Rufael, Y. (2014). Financial development, trade
openness and economic growth in African countries: New insights from a panel causality
approach. Economic Modelling, 37, 386-394.

20. Omoke, P. C. (2009). The causal relationship among financial development, trade
openness and economic growth in Nigeria. Trade Openness and Economic Growth in
Nigeria (December 30, 2009).

21. The World Bank, 2020. Financial development. (

https://www.worldbank.org/en/publication/gfdr/gfdr-2016/background/financial-
development)
22. Yucel, F. (2009). Causal relationships between financial development, trade openness
and economic growth: the case of Turkey. Journal of Social sciences, 5(1), 33-42

26