Financial Deepening and Economic Growth Linkages: A Panel Data Analysis

Author(s): Nicholas Apergis, Ioannis Filippidis and Claire Economidou

Source: Review of World Economics / Weltwirtschaftliches Archiv, Vol. 143, No. 1 (Apr.,
2007), pp. 179-198
Published by: Springer
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 Financial Deepening and Economic Growth
Linkages:A Panel Data Analysis

NicholasApergis, andClaireEconomidou
IoannisFilippidis,

ofPiraeus,Piraeus; UtrechtSchoolofEconomics,University
University of Utrecht

Abstract:The paperexamineswhether a long-runrelationship betweenfinancial

development and economicgrowthexistsemploying panelintegrationand coin-
tegrationtechniquesfora dynamic heterogeneous panelof 15 OECD and 50 non-
OECD countriesovertheperiod1975-2000.Threedifferent measuresof finan-
cialdeepening areusedto capturethevariety channelsthrough
ofdifferent which
financial
development can affectgrowth.Our findings supportthe existenceof
a singlelong-runequilibriumrelationbetweenfinancialdeepening,economic
growthand a setof controlvariables.Further,theevidencepointsto a bi-direc-
tionalcausalitybetweenfinancial
deepening and growth.JELno. Oil, 016, C33
Keywords: Financialdevelopment;growth; panelcointegration;panelcausality

1 Introduction

Academicresearchon the finance-growth nexusdatesback at least to

Schumpeter (1911) who emphasizedthepositiveroleof financialdevel-
opment on economic growth.1The contributionofthefinancial markets
to growthhas receivedconsiderable attentionwiththeemergence of the
endogenous growth however,
theory,2 therelated started
literature expand-
ingvigorously especially theseminalstudyofKingandLevine(1993a,
after
1993b),3whichrevived andgavea boosttoa plethora
theinterest ofresearch.

Remark:Please address correspondenceto Nicholas Apergis,Universityof Piraeus, Piraeus

18534, Greece; e-mail: napergis@unipl.gr
1 The literatureidentifiescertainchannels
throughwhich financialmarketsexertinfluence
on growth.In particular,financialmarkets:(i) reduce transactioncosts and facilitateman-
agementrisk,(ii) mobilize and pool savings,(iii) ease the exchangeof goods and services,
(iv) produce informationex ante about possible investments, and (v) monitorinvestments
and exertcorporategovernance.
2
See, among others,Obstfeld(1994), Bencivengaet al. (1995), and Greenwoodand Smith
(1997), who account forfinancialintermediaries, risk sharingetc. in theirmodels.
5 This work has become the since it introducesfourmeasuresof finan-
point of reference,
cial development,which are widelyused in the literature:the ratio of the liquid liabilities

© 2007 Kiel Institute DOI: 10.1007/S10290-007-0102-3

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180 ReviewofWorldEconomics2007,Vol. 143 (1)

Broadlyspeaking, therearefourviewsexpressed forthefinance-growth

nexus. The firstone is thesupply-leading view,whichsupportsa posi-
tiveimpactoffinancial development on economic growth.4 The demand-
following view,whichstatesthatfinance actuallyresponses to changesthat
happenintherealsectoror"whereenterprise leads,finance follows"
Robin-
son( 1952).5Somewhere betweenthesetwoviewsistheonethatclaimsmu-
tualimpactoffinance and growth.6 therearesomestudiesarguing
Finally,
thatthereis no relationshipat all.7
Despitethegreatdealofeffort devotedempirically in disentanglingthe
impact offinancial on as as
development growth accurately possible, there
is stillno consensusas to theexistence, thelevel,or thedirection ofsuch
relationship. Cross-country8and, more recently,panel data studies9show
evidenceof a positiveimpactof financialdevelopment on growthwhile
timeseriesstudies,on theotherhand,offer contradictory results.10
Thereare a numberof concernswiththepreviousliterature. An im-
portant drawbackin the cross-sectionalmethodology is the to
inability
discusstheintegration and cointegration properties ofthedata,and fur-

of thefinancialsystemto GDP,the ratioof bankcreditto bankcreditpluscentralbank

domesticassets,the ratioof creditallocationto privatebusinessto totaldomesticcredit
and theratioof creditto privatebusinessto GDP.
4 to thisapproach,thereis a robusteffect thatrunsfromfinancial intermedi-
According
ationto economicgrowth, and is exercisedeitherby raisingthe efficiency
of capitalac-
cumulation(Goldsmith1969) or by raisingthesavingsrateand thustheinvestment rate
(Shaw 1973).Thisviewis supported bySchumpeter (1911),Gurleyand Shaw(1955),and
recentempiricalstudiesof Roubiniand Sala-i-Martin (1992), Kingand Levine(1993a,
1993b)and Rousseauand Wachtel(2000) amongothers.
3 The viewdoesnotreallydenythattheremightbe reverse causationfrom
supply-leading
growthto finance;ratherit stresses thatthefinance-growth linkis robustto suchreverse
causation.The studiesof Friedman and Schwartz (1963),Jung(1986),and Ireland(1994)
provideempiricalsupportofthisview.
6 Demetriadesand Hussein
(1996) and Greenwoodand Smith(1997) are some of the
studiesthatprovideevidenceofbi-directional causality.
7 For instance,Lucas (1988) rejectstheexistence of a finance-growth claim-
relationship,
ingthat"economists badlyoverstress theroleoffinancein economicgrowth".
0 See Goldsmith
(1969), Kingand Levine(1993a,1993b)and Levineand Zervos(1998),
amongothers.
9 LaPortaet al. (1997, 1998,
1999),Levine(1998, 1999),Becket al. (2000),Levineet al.
(2000), Rousseauand Wachtel(2000), and Beckand Levine(2004) use legaland regula-
toryaspectsof corporatefinanceas instrumental variablesforfinancialdevelopment and
GMM dynamicpanelestimator to accountforsimultaneity.
10 Wachteland Rousseau
(1995) and Rousseau(1998) supportthefinance-led-growth hy-
pothesiswhileArestisand Demetriades (1997),Luinteland Khan(1999) and Arestiset al.
(2001),amongothers,supportthebi-directional causality.

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 Financial Deepening and Economic GrowthLinkages181
Apergis/Filippidis/Economidou:

ther,to examinethedirection ofcausality betweenfinancial development

and economicgrowth.
Whenitcomestotimeseriesstudies, although oneis abletoidentify the
direction ofcausality andthenatureofthe1(1)variables istakenintoaccount
in theestimation techniques, thereis alwaysthepossibility of misleading
standard testsand unreliable resultsdue to shortlengthofdatasets(Pierse
and SheU1995).
Finally, paneldatastudiesmakea seriousattempt tocontrolforpossible
shortcomings of the two
previous methodologies byaccounting forother
determinants ofgrowth to avoidpotential biasesinducedbyomittedvari-
ables,correcting forsimultaneity using instrumental variablesand GMM
dynamic panel estimator, and controlling for unobserved country-specific
effects. However, theyignoretheintegration properties oftheirdata.There-
fore,itis notclearwhether theyeventually estimate a long-run equilibrium
relationship between finance and or a
growth spurious one offeringthus
misleading conclusions.
Consequently, thepurposeof thepresentpaperis to re-examine the
natureof the finance-growth relationship and providebetterempirical
insights the
byconsidering application of novel econometric techniques -
panelcointegration andpanelestimation - thatexploitthefullinformation
ofthedata while correcting at the same timemanyof theshortcomings
mentioned above.
To ourknowledge, thereis onlyone studyso farin thefinance-growth
nexusliterature thatemployspaneldatacointegration techniques to inves-
tigate the nature of thisrelationship. Christopoulos and Tsionas (2004),use
panelcointegration analysisto examinewhethera long-runrelationship
betweenfinancial development and economicgrowthexistsfor10 devel-
oping countries over the period1970-2000.Theirfindings aresupportive
a
to uniquecointegrating vector between growth, financial development,
investment share,and inflation, andtounidirectional causality fromfinan-
cial depthto growth.However,thisstudylimitsitsattention onlyto few
developing countries and employs onlyone measure of financial deepening.
The presentpaperaimsto contribute to therelevant literature in the
following ways:
i) On theeconometric front, we makeuse ofpanelunitroot(Im et al.
2003) and panelcointegration (Pedroni1999)allowingforheterogene-
tests
ityin coefficients and dynamics acrossunits,whichenableus to determine
thelong-runstructure of thefinance-growth relationship avoidingwell-
knownproblems thatoccurinusingtraditional (timeseries)cointegration

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182 ReviewofWorldEconomics2007,Vol. 143 (1)

testing(low-powerdue to smallsamples).The cointegrating vectorsare

estimatedusingdynamicOLS (DOLS) procedure, whichallowsforcon-
sistent and efficient estimators ofthelong-runrelationship, dealswiththe
endogeneity of the regressors and takes into account theintegration and
cointegration properties of the data.
ii) Weattempt to resolvetheissueofcausality, i.e.,whether betterfunc-
tioning financial markets exert a causal influence on growth viceversa
or
the
following methodology of Pesaranet al. (1999).
iii) We employvariousmeasuresoffinancial development in orderto
quantify theimpactoffinancial depthon growth and,further, to examine
thesensitivity oftheresults. Themajority ofthepreviousstudiesusea single
measureoffinancial development and base theirfindings solelyon it.But
no measureis perfect, and further, therearemanychannelsthrough which
financial deepeningcouldimpacton growth and thesechannelscannotbe
exploredbyemploying a
only single indicator.
iv) To controlforpossibleomitted variablebias,we includea complete
conditioning information set consisting of variablesborrowedfromthe
relevant literature.
v) We usea largeand heterogeneous sampleof65 countries (15 OECD
and 50 non-OECD) overtheperiod1975-2000.
Our findings indicatethatthereis clearly a positiveassociationbetween
financial deepening andeconomicgrowth. Further, theresults supporta bi-
directional causality betweenfinancial deepening andgrowth forthepanels
ofOECD and non-OECD countries. We concludethatpoliciesaimingat
improving financial markets (economicgrowth) willhave,in thelong-run,
a significant effect on economicgrowth (financial development).
The remainder ofthepaperis organizedas follows:Section2 presents
themodelunderestimation and data.The econometric methodology is
introduced in Section3. Section4 estimates theeconometric specification
and discussestheempirical results.Section5 concludes.

2 Model Specificationand Data

The specification
we use to testforcointegration
and causalitybetween
financial
depthand growth, is thefollowing:
yit= doi+ auFit+ <*2iXit+ uit, (1)
wherey^is GDP percapita;F{tis a measureoffinancial X¡tis
development;
a setofcontrolvariables,
and U{tis theerrorterm.

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 Financial Deepening and Economic GrowthLinkages183
Apergis/Filippidis/Economidou:

An interesting and controversial viewof thefinance-growth nexusis

thatthe magnitudeof financialdevelopment's impacton growthvaries
depending on the type of the financialindicator employed andthelevelof
thecountry's development.
To addressthisconcern, we examinetheimpactofthreedifferent mea-
suresoffinancial development. The first one is theliquidliabilities
ofthe
financialsystem (LL),which isdefinedas currency plusdemand andinterest-
bearingliabilities ofbankand non-bankfinancialintermediaries divided
by GDP (M3/GDP). This is the broadest measure of financialdepthused,
sinceit includesall typesof financialinstitutions (centralbank,deposit
moneybanks,and otherfinancial institutions). The secondindicator, bank
credit(BC), isdefined as creditbydepositmoneybankstotheprivate sector
dividedbyGDP whilethethirdone,privatesectorcredit(PC), equalsthe
valueofcredits bydepositmoneybanksand otherfinancial institutions
to
theprivate sectordividedbyGDP.11
The information setof controlvariables, X,r,includesvariablescom-
monly used in the literature (Beck et al. 2000;Levineet al. 2000) suchas
averageyearsofschooling, to controlforthelevelofhumancapital;out-
put share of investment (Christopoulos andTsionas2004)andgovernment
splending as share of GDP both used as indicators ofmacroeconomic sta-
bility(Easterlyand Rebelo 1993; Fischer 1993)and volume of tradeas share
ofGDP,to capturethedegreeofopenness.12
Weexpectthecoefficient on secondary schoolingto be positive.Abra-
movitz(1986) andLucas(1993) amongothersarguethata better-educated
11 The indicatorsBC and PC isolate creditissued to the
privatesector,however,PC might
be more comprehensivethan BC in our specification,since it includes non-bank creditto
the privatesector.
12 Our initial
specificationincluded also inflationas an indicatorof macroeconomic sta-
bility,but the resultsshowed that its coefficientwas statisticallyinsignificant.This find-
ing is not surprising,since many studies find that inflationhas an insignificanteffecton
growth(Beck et al. 2000; Christopoulosand Tsionas 2004). A possible explanationforthis
is that there are non-linearitiesand thresholdsin the inflation-growth effect,suggesting
that statisticallysignificanteffectsarise only when high-inflationexperiencesare included
(Barro 1997; Bruno and Easterly1998; Rousseau and Wachtel 2000). Moreover,the in-
significantinflationcoefficientscan be due to positive (Phillips curve) and negativeinfla-
tion effectsthat offseteach other. Finally,Levine and Renelt (1992) found the relation-
ship to be weak in growthequations that include the investmentto GDP ratio,which sug-
geststhat the directinflationchannel mightbe less importantthan a channel that works
throughfinanceand investment.Some studies,for instance,Levine and Zervos (1993) do
not include inflationin the same equation togetherwith investment.Having all these in
mind, we estimatethe model includinginvestmentshare and governmentsplendingas in-
dicatorsof macroeconomic stability.

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184 ReviewofWorldEconomics2007,Vol. 143 (1)

populationaugments a country's abilitytoabsorbandadoptnewtechnolo-

giesand to innovate; therefore,itis an important factorofgrowth.
Wealsoexpectthecoefficient on theinvestment sharetobe positive. The
neoclassical growth theory argues thatan increasein investment levelraises
thesteady-state levelofoutputperworker and,therefore, raisesthegrowth
rateofoutputwhiletheendogenousgrowth focuseson economiesofscale
and spillover effectsto justifythewaythatincreasedinvestment promotes
growth.
Whenit comesto theeffect ofgovernment spendingon productivity
thiscanbe ambiguousas itdependson thenatureofspending. According to
Barroand Sala-i-Martin (1995),productive -
spending spending on edu-
cation,infrastructure or someotherformofproductive capital- promotes
growth while non-productive spending could obstruct growth. Addition-
allyto thenotionof non-productive spending, we expectthecoefficient
ofgovernment sizeto be negativemostlydue to thecrowding-out effect:
higherspending undermines economic growthbytransferring additional
resources fromtheproductive sectoroftheeconomytogovernment, which
usesthemlessefficiently.13
Finally,we includethevolumeoftradeinorderto measuretheeffect of
openness to therestof the world.Trade, eitherin theform ofexports or im-
ports,isa proxyofgrowth-enhancing interactions (specialization,exchange
ofideasthrough exportsor acquiringforeign technology throughquality
imports)amongcountries actingas conduitforknowledge dissemination,
thusmoreopeneconomiesshouldexhibit highergrowth rates.14Therefore,
theestimated coefficient on tradesharein our specification is expectedto
be positive.15
All data are annualand takenfromthe WorldDevelopment Indica-
tors,WorldBank (2002), exceptforhumancapitaldata,whichare re-
trievedfromBarroand Lee (1993, 2001). The data on humancapital
are providedquinquennially. FollowingHarrigan(1997), we interpolate
between five-yearly observationsusing linear Stata's interpolation
function.16 A sampleof 65 (15 OECD and 50 non-OECD) countriesis

13 See Barro and Rebelo(1993),and Fölsterand Henrekson

(1991),Easterly (2001).
14 See Grossmanand
Helpman(1991a, 1991b,1995),Edwards(1992), Barroand Sala-i-
Martin(1995),and Frankeland Romer(1999),amongothers.
lD Recentstudiestendto findthattheeffectoftradeon growth(and incomeconvergence)
is ratherambiguousor insignificant
(Rodriguezand Rodrik1999).
16 Formoredetailsaboutthe
sampleof countries
and thedefinitionofvariables,
see Ap-
pendix,TablesAl and A2, respectively.

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 Financial Deepening and Economic GrowthLinkages185
Apergis/Filippidis/Economidou:

employed. The panelofthecountries includesalmostall different

income
ofdeveloping
categories countries'low,middle,andhighincome.Thetime
periodcovers theyears from 1975 to 2000- thelongesttimeperiodfor
whichall variableswereavailableforthemaximumnumberof countries
underinvestigation.

3 EconometricMethodology

We employpanelcointegration techniquesusingthepanelcointegration
methodology developedbyPedroni(1999),whichstudiestheproperties of
spuriousregressions,tests
for in
cointegration heterogeneous panelsand
derives
appropriate forthesecases.ThePedronimethodology
distributions
allowsone to testforthepresenceoflong-runequilibriain multivariate
panelswhilepermitting thedynamicand eventhelong-runcointegrating
vectors
tobe heterogeneous acrossindividual
members. weexplore
Finally,
thecausallinksbetweenfinancialdevelopment and economicgrowth using
themethodology ofPesaranetal. (1999).

3.1 Panel Integration

Analysis
Beforeembarking on cointegration techniques,we firstneed to check
whether thevariablesin our modelare stationary or non-stationary,i.e.,
whether theindividual seriescontainunitroots.In doingso,we adoptthe
approachsuggested byIm etal. (2003)- IPS thereafter- sinceitis lessre-
and morepowerful
strictive compared to someother panelunitroottests,
as shownfromMonteCarlosimulations.17
The testproposedbyIPS allowsheterogeneity betweenunitsin a dy-
namicpanelframework and is based on individualAugmented Dickey-
Fuller(ADF) regressions:
p
yi,t= aw,t-i + E <l>ijAyi,H
+ zùtY+ su , (2)

wherey¡tstandsforeach variableunderconsiderationin our model,p is

thenumberoflagsforcorrelation-freeresiduals, thevectorof
z^tindicates
variablesin themodelincluding
determinisi anyfixed or
effects individual
vectorofcoefficients.
trendsand y is thecorresponding

17 For an
panel-based unit root tests,see Baltagi
exposition and comparison of different
(2005).

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186 ReviewofWorldEconomics2007,Vol. 143 (1)

Thenullhypothesis ofa unitroot(p¿= 0 forall i) versusthealternative

ofno unitroot(p; < 0 forsomei = 1,2,...,Ni andp, = 0fori= Ni+l,...,N,
whereN is thenumberofcross-sections) is thentested.Insteadofpooling
thedataand assumingthatp,isthesameforall members(as in Levinetal.
2002),IPS use separateunitroottestsfortheN cross-sections units.The
in a panelcontextsuggested
teststatistic by IPS, denotedas t-bar,is the
averageof individualADF and
statistics is definedas:

fortesting
wheretpiis theindividual¿-statistic thenullhypothesis. Under
thenullhypothesis ofnon-stationarityIPS showthatthet-statistic
follows
asymptoticallya standardnormaldistribution.IPS providesimulatedcrit-
ical valuesfort fordifferent
numberofcross-sections N, lengthT
series
and Dickey-Fuller regressions
containingintercepts and
onlyor intercepts
lineartrends.

3.2 DynamicHeterogeneity
The heterogeneity ofthecountries includedin thisdatasetis an issueof
concern.In particular, theeffects on thefinance-growth relationshipare
to
expected vary over timeand across countries.
Once is
heteroskedasticity
present, thedatasetcannotbe pooled.Studiesthatdo notexplicitly testfor
cross-country heterogeneityin their samplesraisesome concerns overtheir
findings.
Thedynamic heterogeneity,i.e.,variation
oftheinterceptovercountries
and time,acrossa cross-section oftherelevant variablescan be examined
using standard Chow-type F-tests.Heterogeneity incross-sectionalparam-
etersis indicatediftheresultsrejectthenullhypothesis, whichassertsno
heterogeneityacrosscountries and time.White'stestsforgroup-wise het-
arealsoemployed
eroskedasticity tocontrolforheterogeneityerrorvariance
acrossgroups.

3.3 Panel Cointegration

Analysis
Once theorderofstationarity
has beendefined,
our nextstepis to apply
panelcointegration We adopttheapproachdevelopedby
methodology.18
18 Panel-based testsare proposedby Kao (1999),Larssonet al. (2001), Pe-
cointegration
droni(1999),and McCoskeyand Kao (1999).

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 Financial Deepening and Economic GrowthLinkages187
Apergis/Filippidis/Economidou:

Pedroni(1999).19LiketheIPS panelunit-root test,thepanelcointegration

testsproposedbyPedroni( 1999) alsotakeheterogeneityintoaccountusing
specific
parameters, whichare allowedto varyacrossindividualmembers
ofthesample.
The firststepto applyPedroni(1999) testsforthenullhypothesis of
no cointegrationis to computetheregressionresidualsfromthehypothe-
sizedcointegrating In
regression. themost generalcase,thismaytakethe
form:

At = a'i + %* + *uX'ut+ a2ix2i%t

+ + UMiXMUt
+ eut (4)

fort=l ,...,T; i = 1 ,...,N; m = 1 ,...,M ,

whereT refers tothenumberofobservations overtime;N refers tothenum-

berofindividual members inthepanel;M refers tothenumberofregression
variables;au, â2i>...>âMiaretheslopecoefficients; á¡ is themember-specific
intercept or fixed effects and
parameter; a¡t is thedeterministic timetrend
whichis specific to individualmembers of the panel.
Pedroni(1999) derivedtheasymptotic distributions and exploredthe
smallsampleperformances of sevendifferent statisticsto testpaneldata
cointegration. These differentstatistics are based on a modelwhichas-
sumesthatcointegration are
relationships heterogeneous betweenindi-
vidualmembers.The firstfourteststatistics are based on the "within"
dimension (panelcointegration The
statistics). nullhypothesis is Ho: a,-= 1
(i.e.,no cointegration) andthealternative hypothesis isH} : a, = á < 1,while
thelastthreeteststatistics are based on the "between" dimension(group
meanpanelcointegration statistics)and thealternative hypothesis in this
caseis Hi : a, < I.20

3A Panel Cointegration Estimation

Givenourvariables weestimate
arecointegrated, thelong-run relationship
the
using dynamic OLS (DOLS) approachproposedby Stockand Watson
(1993). It is wellknown thatthe OLS of
estimates the re-
cointegration
gressionequationarebiaseddue to endogeneityand serial In
correlation.

19 Gutierrez
(2003) shows that as T gets large,the Pedroni testshave higherpower than
Kao (1999) testsand both outperformthe Larsson et al. (2001) LR-bar test.
20 The discussion and mathematical
expositionsof these statisticsis contained in Pedroni
(1999).

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188 ReviewofWorldEconomics2007,Vol. 143 (1)

theDOLS estimation, extratermsareaddedto theoriginalcointegration

Thesetermsconsistoflagsandterms
equation,so thatthebiasis corrected.
ofthefirstorderdifferences oftheexplanatory
variables:

yut= Maß + 11 cAxìj + /¿¿+ uu , (5)

wherec; is thecoefficient
of a lead or lag of firstdifferenced
explanatory
variables.

3.5 Panel Causality

Our finalstepconsistsofexploring
thedirectionofthepaneldatacausal
linksamongthevariablesunderconsideration.
Weestimate causalityusing
the Pooled Mean Group(PMG) estimator of Pesaranet al. (1999). For
thispurpose,we have specifiedan errorcorrectionVAR model of the
form:
p-'
Ay,=ao + alt + ßtft-x+ #>**-i+ £ <t>i&yt-i
«>

1=1

whereytrepresents thedependent variable,xtis a vectorofpossiblylong-

runforcing ß' andßi arctherespective
variables, long-run and
multipliers,
(f>iand 0i representtheshort-run dynamic coefficients.
Byinterchanging
ytand xtas dependent and independent variablesin theaboveregression,
we can assess,underthenullhypothesis ofnon-existence of a long-term
relationship = =
(Ho: ß' 0 and ß2 0) and thealternative ofexistence(Hi:
ßY jL 0 orß2 =¿0), whichvariableis theforcingone.

4 EmpiricalResults

4.1 DynamicHeterogeneity
Beforeemploying we first
panel-basedanalysis, testforheterogeneity.
The
resultsof standardChow-typeF-testsand White'stestsare reportedin
Table 1. The empiricalfindingsindicatethatthe relationshipunderin-
vestigationis characterized of
byheterogeneity dynamics and error
vari-
ance acrossgroups,supporting the applicationof panel data method-
ology.

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 Financial Deepening and Economie GrowthLinkages1 89
Apergis/Filippidis/Eœnomidou:

acrossGroups
Table 1: TestsofDynamicHeterogeneity

ADF(3) AR(3) White'stest

Growth-LL 12.91* 26.31* 57.62*

Growth-BC 11.57* 24.49* 56.29*
Growth-PC 13.08* 29.39* 60.93*
*
Significantat 1 percent.
Note: The ADF(3) column reportsthe parameterequalitytest (F-test) across all relation-
ships in the panel. The AR(3) column reportsthe F-testof parameterequalityconductedin
a fourth-order autoregressivemodel of the relationshipsunderstudy.Finally,the White'stest
relationshipsin the panel.
reportsWhite'stestof equalityof variancesacross the investigated

4.2 Panel UnitRootsResults

The resultsfromthepanelunitroottestarepresented in Table2 and are

reported with a trend.The variables of growth(y), measures of financial
development (LL,BCyPC) and all controlvariables(H, J,G, T) aretested
bothin levelsand in firstdifferences.As itcan be inferredfromthistable,
we cannotrejecttheunit-root hypothesis when the variablesare takenin
levels,butwhen first
differences are the
used, hypothesis of unit rootnon-
is rejectedat the1 percent
stationarity of
level significance.Therefore, our
seriesarewellcharacterized as an 1(1) process.Theseresultsallowus totest
forcointegration among the variables in consideration.

Results
4.3 Panel Cointegration

Thecointegration arereported
results inTable3. The calculatedteststatis-
ticsrejectthenullhypothesisofabsenceofcointegration at 1 percentfor
thethreegroupsofcountries (OECD countries,non-OECD countries, all
countries)and forthethree of
indicators financialdevelopment. Moreover,
we noticesubstantially
largerpanelcointegration in thegroupof
statistics
non-OECDcountries, providingsupporttotheproposition thata moreper-
ceptibleandstrongcorrelationbetweenfinancialdevelopment and growth
and/orin themiddlestagesofeconomicdevelopment.
existsinthefirst

4.4 Panel EstimationResults

theresultsfrom
equation(1). Table4 presents
The nextstepis to estimate
thedynamicOLS (DOLS) estimates ofthecointegrating The
relationship.

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190 ReviewofWorldEconomics2007,Vol. 143 (1)

Table 2: Panel UnitRoot Tests

Levels Differences

OECD countries
Output(y) -2.54 -4.67*
Liquidliabilities
(LL) -1.79 -5.93*
Bankcredit(BC) -1.84 -4.91*
Privatecredit(PC) -2.02 -4.61*
Humancapital(H) -1.17 -3.96*
Investmente/) -1.74 -4.83*
Gov.expenditure (G) -2.31 -5.10*
Tradevolume(T) -2.25 -4.33*
Non-OECDcountries
Output(y) -2.39 -4.51*
Liquidliabilities
(LL) -1.52 -4.79*
Bankcredit(BC) -1.62 -4.58*
Privatecredit(PC) -2.14 -5.11*
Humancapital(H) -1.39 -4.48*
Investment(/) -1.83 -4.29*
Gov.expenditure (G) -1.92 -4.23*
Tradevolume(T) -2.69 -4.81*
Allcountries
Output(y) -2.31 -4.61*
Liquidliabilities
(LL) - 1.84 -4.5 1*
Bankcredit(BC) -1.74 -4.63*
Privatecredit(PC) -1.83 -4.60*
Humancapital(H) -1.15 -4.72*
Investment(I) -1.52 -4.38*
Gov.expenditure (G) -2.12 -4.46*
Tradevolume(T) -2.19 -4.74*
* at 1 percent.
Significant

estimated coefficients
ofthefinancialindicators(LI, BC,PC) areallpositive
and statistically inall groupsofcountries.
significant
In addition,thecoefficients of averageyearsof schooling,investment
shareand tradecarrythe expectedsignand are statistically significant.
Government expenditure exhibitsa statistically positivecoef-
significant
ficientin the OECD countries, but a statistically negativeco-
significant
efficientin the groupof non-OECD countries.This pointsto a low ef-
ficiencyof government spendingin thelattergroup.Overall,theresults
providestrongevidencethatfinancial depthhasa robustpositiveeffect on
output.

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 Financial Deepening and Economic GrowthLinkages191
Apergis/Filippidis/Economidou:

Tests
Table 3: Panel Cointegration

Liquid liabilities Bank credit Privatecredit

(LL) (BC) (PC)

OECD countries
Panel statistics
Panel v-stat -4.02981* -3.50531* -4.29471*
Panel rho-stat -3.09591* -3.27199* -3.76067*
Panel pp-stat -2.99396* -2.83468* -3.36376*
Panel adf-stat -2.94623* -2.35378* -2.88209*
Groupstatistics
Group rho-stat -3.91170* -3.78519* -3.80675*
Group pp-stat -3.92500* -3.72465* -3.63044*
Group adf-stat -3.51568* -3.62248* -3.44706*
Non-OECD countries
Panel statistics
Panel v-stat - 10.54827* - 10.54800* - 10.54803*
Panel rho-stat -13.64251* -13.58308* -13.80304*
Panel pp-stat -27.59465* -25.14156* -34.38417*
Panel adf-stat -26.60703* -25.17688* -34.23049*
Groupstatistics
Group rho-stat -17.19755* -17.56509* -17.57358*
Group pp-stat -33.40626* -35.29265* -33.53099*
Group adf-stat -33.67768* -35.37389* -32.97982*
All countries
Panel statistics
Panel v-stat -5.28594* -5.11365* -5.46609*
Panel rho-stat -5.42015* -4.73989* -4.62555*
Panel pp-stat -4.65966* -4.39002* -4.43891*
Panel adf-stat -3.20558* -3.73080* -3.47670*
Groupstatistics
Group rho-stat -7.54334* -6.57647* -7.23176*
Group pp-stat -6.25952* -5.62218* -6.42066*
Group adf-stat -4.43494* -5.74535* -6.83954*

*
Rejectionof the null hypothesisof no cointegrationat 1 percent.

4.5 Panel CausalityResults

Havingestablished thatgrowthis cointegrated withall controlvariables,
to examine
itis also appropriate the multivariate
associated rela-
causality
tionship. Considering equation,theassociated
that(1) is thecointegrating

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192 ReviewofWorldEconomics2007,Vol. 143 (1)

Table 4: DOLS Estimates

Dependentvariable:y Liquidliabilities Bankcredit Private

credit
(LL) (BC) (PC)
OECD countries
Finance(F) 0.071(4.66)* 0.019(3.04)* 0.018(3.93)*
Humancapital(H) 0.054(4.11)* 0.632(3.91)* 0.067(4.53)*
Investment (/) 0.195(15.03)* 0.204(13.14)* 0.193(12.81)*
Gov.expenditure(G) 0.143(4.23)* 0.072(3.95)* 0.131(5.63)*
Tradevolume(T) 0.092(3.78)* 0.078(4.76)* 0.065(4.19)*
Non-OECDcountries
Finance(F) 0.032(3.75)* 0.027(4.12)* 0.024(3.90)*
Humancapital(H) 0.091(3.64)* 0.095(3.78)* 0.107(3.59)*
Investment (/) 0.269(3.96)* 0.261(3.83)* 0.244(8.67)*
Gov.expenditure(G) -0.076 (-4.54)* -0.084 (-3.29)* -0.095 (-2.89)**
Tradevolume(T) 0.088(3.27)* 0.072(4.46)* 0.077(4.75)*
Allcountries
Finance(F) 0.0237(3.62)* 0.0107(4.13)* 0.132(7.20)*
Humancapital(H) 0.046(3.91)* 0.0442(3.59)* 0.0419(4.93)*
Investment (/) 0.138(21.33)* 0.129(19.18)* 0.124(23.54)*
Gov.expenditure(G) -0.064 (-6.95)* -0.086 (-6.08)* -0.083 (-8.99)*
Tradevolume(T) 0.057(4.27)* 0.069(4.75)* 0.0553(5.17)*

t-statistics *
in parentheses: **
at 1 percent at 5 percent.
significant significant

ADRL equationsarealso described

bya (1,1,1)model:
yit= m+ auFij+ ^¿^t-i + *3iiv+i+ *4i*i't
+ a5iXij-i + a6iXu+' + a7¿yf-ft_i
+ uu,t
and

Fit= a{ + a'tfij+ (¿2yut-'

+ 4>V+i + aiiXu „
/ / / ^'

Theerror
correction
equations
yield:
- - -
Ay* = 4>(yÍ9t eoi OuFis d2iXu)
- fu&Fij -
friXij+ «3i,t
and

AFit = 4>{FUt- eoi - duyij ~ 02Ä'r)

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 Financial Deepening and Economic GrowthLinkages193
Apergis/Filippidis/Economidou:

The results
oftheerrorcorrection inTable5.
equationsarereported

Table 5: Panel CausalityTests

Liquidliabilities Bankcredit Private

credit
(LL) (BC) (PC)
OECD countries
DF-*DY -0.071 (-4.36)* -0.068 (-5.83)* -0.054 (-4.61)*
DY-*DF -0.025 (-3.22)* -0.029 (-4.51)* -0.033 (-3.84)*
Non-OECDcountries
DF-+DY -0.084 (-5.87)* -0.076 (-6.39)* -0.089 (-5.58)*
DY-+DF -0.049 (-4.64)* -0.045 (-5.39)* -0.051 (-4.27)*
Allcountries
DF-+DY -0.047 (-5.17)* -0.053 (-4.33)* -0.045 (-4.83)*
DY-»DF -0.029 (-3.91)* -0.037 (-4.19)* -0.037 (-3.98)*
*
in parentheses:
t-statistics at 1 percent
significant

Threeimportant are producedfromTable5: first,

findings the non-
is
hypothesis strongly
causality rejectedin all groupsof second,
countries;
theerror-correction coefficients are and
(</>'s) negative statistically signifi-
cant,indicatingthatfinancialdevelopment does causegrowthand growth
causesfinance,i.e.,thecausalrelationship betweenfinancialdevelopment
and growth and third,
is bi-directional; theresultsarenotalteredwhenwe
introducedifferent offinancial
indicators development.

5 Summaryand ConcludingRemarks

The paperinvestigatesthecausallinkagesbetweenfinancial development

andeconomicgrowth ina largesampleof65 countries, bothdevelopedand
developing,overtheperiod1975-2000.
Overall,ourresultssupporta positiveand statistically equi-
significant
libriumrelationbetweenfinancial development and economicgrowthfor
financial
alldifferent indicatorsthatwetestforandinallgroupsofcountries.
Whenit comesto theauxiliaryvariables,humancapital,investment
share,andinternationaltrade,theirimpactongrowth isfoundtobepositive
and statistically while
significant government spendingexhibits a positive
effectfortheOECD countries, buta negativeeffectforthe groupofnon-
OECD countries.

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194 ReviewofWorldEconomics2007,Vol. 143 (1)

Further,theresults indicatea strongbi-directional

causality betweenfi-
nancialdevelopment andeconomicgrowth. Theimplication isthatpolicies
at
aiming improving financialmarkets and their
functions willhave,inthe
a
longrun, significant on
effect economic growth.Such policiesareespe-
ciallyimportant of
forthegroup developing countrieswhere theimpactof
financialsectordevelopment on growth is foundto be stronger compared
to thatin industrialcountries, the of
underlying significance undertaking
a numberofreforms inthefinancial sectorthatcouldcontribute furtherto
economicgrowth.
Finally,policiesthatfostermacroeconomic increasedopen-
stability,
ness,investment inphysicalandhumancapitalandproductive government
spending,and therefore improveeconomicgrowth, would also havean
important effecton financial
development inthelongrun.

Appendix
Tabie A1: SampleofCountries
OECD Non-OECD
countries countries
Australia Latin Americaand Middle East and SouthAsia
Belgium theCaribbean NorthAfrica India
Canada Barbados Algeria Nepal
Denmark Brazil Egypt,Arab Rep. Pakistan
Finland Chile Iran Sri Lanka
Germany Colombia Israel
Ireland Costa Rica Jordan Sub-SaharanAfrica
Italy Dominican Republic Malta Cameroon
Japan Ecuador SyrianArab Republic
Gambia
New Zealand El Salvador Ghana
Norway Guatemala East Asia and Pacific Kenya
Sweden Honduras Fiji Mauritius
Switzerland Haiti Indonesia Niger
United Kingdom Jamaica Korea, Rep. Rwanda
United States Mexico Malaysia Senegal
Nicaragua Papua New Guinea South Africa
Paraguay Philippines Swaziland
Peru Singapore Togo
Trinidadand Tobago Thailand Zimbabwe
Uruguay
Venezuela,RB

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 Financial Deepening and Economic GrowthLinkages195
Apergis/Filippidis/Economidou:

TableA2: Definition
ofVariables
Variable Description Unitsmeasured Source

Y Output GDP per capita,PPP (constant 1995 World Bank

international$) (CD-ROM, 2002)
LL Liquid liabilities Broad money (M3) as percentof GDP World Bank
(CD-ROM, 2002)
BC Bank credit Domestic creditprovidedby banking WorldBank
sector(percentof GDP) (CD-ROM, 2002)
PC Privatecredit Domestic creditto privatesector World Bank
(percentof GDP) (CD-ROM, 2002)
H Years of schooling Educational attainmentof the total Barro and Lee
population aged 25 and over (1993, 2001)
I Investment Gross capital formation(percentof GDP) WorldBank
(CD-ROM, 2002)
G Gov. expenditure General governmentfinalconsumption World Bank
expenditure(percentof GDP) (CD-ROM, 2002)
T Trade volume (Exports+ imports)/GDP World Bank
(CD-ROM, 2002)

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