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ROLE OF FINANCIAL MARKETS AND
INSTITUTIONS IN ECONOMIC GROWTH:

A DECOMPOSED ANALYSIS
PRESENTED BY: ALISHBAH GUL
SUPERVISOR: DR. MUHAMMAD JAMIL
CO-SUPERVISOR: DR. AHSAN-UL-HAQ SATTI
ROLE OF FINANCIAL MARKETS AND INSTITUTIONS IN ECONOMIC GROWTH: A DECOMPOSED ANALYSIS
LINE OF PRESENTATION
• Introduction
• Literature Review
• Methodology
• Data
• Results
• Conclusion
Alishbah Gul Department of Economics & Finance, Pakistan Institute of Development Economics, Islamabad October 24, 2019
Introduction
INTRODUCTION
• Financial development is:

• More than just a growth signal
• Influences investment decisions
• Enables investors to diversify risks
• Mobilizes and allocates savings
• Thus, relationship of financial development and economic growth is a marriage

made in heaven.
PROBLEM STATEMENT
• If the direction of causality stems from financial development towards economic

growth or vice versa, and if the decomposed analysis of financial sector
development enjoys empirical grounds.
OBJECTIVES OF THE STUDY
• To present a decomposed analysis of the region-wise financial sector

development, and
• To investigate the impact of the (decomposed) financial sector development
on economic growth in both developed and developing countries.
HYPOTHESES OF THE STUDY

• 𝐻01: Financial depth, accessibility and efficiency of the financial markets have insignificant
impact on economic growth.
• 𝐻11: Financial depth, accessibility and efficiency of the financial markets have significant impact
on economic growth.
• 𝐻02: Financial depth, accessibility and efficiency of the financial institutions have insignificant
• 𝐻12: Financial depth, accessibility and efficiency of the financial institutions have significant
CONTINUED
• 𝐻03: Financial depth, accessibility and efficiency of the financial markets do not
have same effect on economic growth for developed and developing countries.
• 𝐻13: Financial depth, accessibility and efficiency of the financial markets have
same effect on economic growth for developed and developing countries.
SIGNIFICANCE OF THE STUDY
• Provides policymakers with comprehensive knowledge for financial and

economic decision making by investigating the region-wise effect of financial
sector (including both institutions and markets) development on economic growth
by providing a decomposed analysis of financial development for both developed
and developing countries.
Review of Literature
PRIME INDICATORS OF FINANCIAL DEVELOPMENT

Indicators Literature
Investment in private sector projects Beck et al. (2005; 2011)
Exports McKinnon (1973)
Broad money Kabir and Haque (2007)
Domestic credit to private sector Kabir and Haque (2007)
Investment loans and consumption loans Hung (2009)
Monetary aggregates Darrat (1999); Liu et al., (1997); Jung (1986); Calderón and Liu (2003)
Inflation Paul et al., (1997); Ghosh and Phillips (1998); Mallik and Chowdhury
(2001); Mubarik (2005); Datta (2011)
CONTINUED
Indicators Literature
Deposit based financial indicators Levine et al. (2000)
Gross capital formation Shahid (2014)
Trade openness Newbery and Stiglitz (1984); Rajan and Zingales (2003); Braun and
Raddatz (2005); Svaleryd and Vlachos (2005); Do and Levchenko (2007)
Labor force participation Lawson et al. (2010); Bridges et al. (2011); Shahid (2014)
Domestic credit provided by private sector Levine (2005)
Foreign direct investment Carkovic and Levine (2002); Hermes and Lensink (2003); Alfaro et al.
(2004); Johnson (2006); Falki (2009); Khan and Khan (2011); Melnyk et
al., (2014)
Credit based financial indicators King and Levine (1993); Demetriades (1997); Calderón and Liu (2003)
FINANCIAL DEVELOPMENT INDEX
Methodology
THEORETICAL FRAMEWORK
Step 1: Regression Analysis

Step 2: Diagnostic Tests
a. Fixed Effect Model
b. Random Effect Model a. Hausman's Test
ECONOMETRIC MODEL
• King and Levine (1993):
• .....(1)
• Fixed effect model:

• + …..(2)
• Random effect model:

• + …..(3)
Data
SOURCES OF DATA
Africa • 73 countries (41 countries are developed whereas remaining 32
are developing countries)
The Americas
• 37 years (1980 to 2016)
World Asia • The yearly data of gross domestic product and financial sector
development index has been taken from the official website of
Europe the World Bank.
• The yearly data of the control variables has been taken from the
official website of the World Development Indicators by the
Middle East World Bank.
• There are 2701 observations for each variable (73 countries into
Oceania
37 years).
VARIABLE DESCRIPTION
•• Dependent
Variable:
• is rate of economic growth, i.e., GDP per capita
• Independent Variable:
• represents financial sector development index
• Control Variables:
• is inflation,
• is foreign direct investment
• is gross capital formation (% of GDP)
• is trade openness (% of GDP)
• is total labor participation, and
• is domestic credit by financial sector (% of GDP)
DESCRIPTIVE STATISTICS
0.8
0.7
0.6
0.5 Average of Americas

Average of Africa
0.4 Average of Asia
Average of Oceania
0.3 Average of EU
Average of Europe
0.2 Average of Middle East
0.1
0
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16
19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20
Results
RESULTS OF PANEL REGRESSION

Regions Africa Americas Asia Europe
Models Fixed Effects Random-effects Fixed Effects Random-effects Fixed Effects Random-effects Fixed Effects Random-effects
Constant 2.233 1.770 2.972 3.032 2.287 2.187 2.987 3.633

(0.000)* (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
FDI -3.2e-12 2.76e-11 -4.1e-13 -3.8e-14 3.4e-12 2.96e-12 3.9e-12 5.13e-12
(0.687) (0.036) (0.188) (0.884) (0.000) (0.000) (0.011) (0.007)
CAP 0.007 0.0133 0.010 0.010 0.125 0.013 -0.0015 0.0015
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.596) (0.705)
DFS -0.002 -0.009 -0.000 -0.0004 0.0002 -0.001 0.0008 0.0018
(0.000) (0.025) (0.285) (0.200) (0.628) (0.007) (0.027) (0.001)
LAB 9.48e-9 4.28e-09 4.82e-09 1.61e-09 2.4e-10 -3.62e-10 1.9e-08 -1.13e-08
(0.000) (0.000) (0.001) (0.021) (0.150) (0.000) (0.000) (0.000)
TOP -0.010 0.004 0.0009 0.0009 -0.001 0.0001 -0.002 -0.0029

(0.069) (0.000) (0.031) (0.023) (0.000) (0.415) (0.009) (0.004)
INF 1.37e-12 -2.8e-11 -4.2e-14 -2.5e-13 -1.7e-12 -1.06e-12 -1.9e-12 -3.03e-12
(0.919) (0.257) (0.971) (0.839) (0.234) (0.289) (0.054) (0.058)
FID 1.645 1.079 0.303 0.375 0.880 1.048 0.991 -0.199

(0.000) (0.000) (0.036) (0.007) (0.001) (0.000) (0.000) (0.442)
FIA 1.322 1.570 1.240 1.246 0.673 0.568 0.277 0.334
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.031) (0.000)
FIE 0.247 0.470 -0.516 -0.526 0.149 0.210 2.213 0.426
(0.001) (0.000) (0.000) (0.000) (0.104) (0.002) (0.095) (0.005)
FMD -0.020 0.482 0.739 0.709 0.586 0.634 -0.0009 -0.025
(0.894) (0.002) (0.000) (0.000) (0.000) (0.000) (0.994) (0.894)
FMA 0.172 -0.732 -0.254 -0.077 0.115 0.160 0.119 0.549
(0.169) (0.000) (0.017) (0.411) (0.218) (0.014) (0.168) (0.000)
FME 0.312 0.165 -0.379 -0.451 -0.027 -0.087 0.009 0.267
(0.014) (0.345) (0.000) (0.000) (0.532) (0.029) (0.855) (0.000)
F-Stats 98.47 39.12 13.15 68.68
P value 0.000 0.000 0.000 0.000
N 444 814 407 185
n 12 22 11 5
T 37 37 37 37
Hausman 559.59 17.04 1217.63 1019.69
(0.0000) (0.0297) (0.0000) (0.0000)
CONTINUED
Regions European Union Oceania Middle East
Models Fixed Effects Random-effects Fixed Effects Random-effects Fixed Effects Random-effects
Constant 3.236 3.110 3.482 3.670 3.229 3.362

(0.000)* (0.000) (0.000) (0.000) (0.000) (0.000)
FDI 4.35e-13 4.21e-13 2.16e-12 4.06e-12 3.55e-12 -2.38e-12
(0.006) (0.015) (0.117) (0.000) (0.214) (0.483)
CAP -0.0008 -0.0003 0.009 0.008 0.008 0.005

(0.651) (0.847) (0.011) (0.027) (0.000) (0.006)
DFS 0.0013 0.0012 0.004 0.004 -0.001 -0.004
(0.000) (0.000) (0.000) (0.000) (0.378) (0.000)
LAB -7.2e-09 2.09e-09 2.74e-08 -9.14e-10 2.89e-09 -5.27e-09
(0.308) (0.133) (0.062) (0.860) (0.187) (0.000)
TOP 0.002 0.0023 -0.006 -0.004 -0.0013 -0.0005

(0.000) (0.000) (0.011) (0.065) (0.079) (0.419)
INF -3.4e-13 -3.34e-13 -7.5e-13 -1.69e-12 3.50e-12 1.05e-12
(0.048) (0.076) (0.386) (0.027) (0.386) (0.846)
FID 0.343 0.525 0.299 0.380 0.447 1.225

(0.000) (0.000) (0.076) (0.022) (0.256) (0.000)
FIA 0.740 0.419 0.054 0.025 0.702 0.322
(0.000) (0.000) (0.744) (0.881) (0.000) (0.077)
FIE -0.120 0.057 0.055 0.020 0.196 0.577
(0.081) (0.406) (0.765) (0.912) (0.223) (0.002)
FMD 0.387 0.445 -0.199 -0.095 0.146 0.546
(0.000) (0.000) (0.133) (0.441) (0.014) (0.004)
FMA 0.2007 -0.0184 0.060 0.044 -0.112 0.190
(0.002) (0.769) (0.517) (0.639) (0.136) (0.019)
FME -0.242 -0.204 -0.134 -0.200 3.229 3.362
(0.000) (0.000) (0.129) (0.016) (0.000) (0.000)
F-Stats 54.67 4.38 41.91
P value 0.000 0.040 0.000
N 555 74 185
n 15 2 5
T 37 37 37
Hausman 143.10 2852.71 568.45
(0.0000) (0.0000) (0.0000)
RESULTS SUMMARY
• The results assure the finance-growth nexus in the Americas and African
countries via trade liberalization, which reduces the power of control groups
blocking financial development in a market (Carkovic and Levine, 2005).
• For the regions, i.e., Asia, Europe, European Union, Oceania, and Middle East,
financial development, via the route of foreign investment opportunities, which
swell gross capital formation and labor force participation, maintain a positive
relation with economic growth (Carkovic & Levine, 2002; Khan & Khan, 2011).
Conclusion
CONCLUSION
• The results concludes that (i) a well-performing financial system eases the
external financial constraints impeding expansion of firm and industry, (ii)
simultaneity bias does not play a role in reaching to the conclusions, and (iii)
countries with better performing markets and banks grow faster, vis-à-vis
economic growth.
POLICY RECOMMENDATIONS
• The region-wise financial reforms must aim at

• reducing foreign direct investment volatility by increasing stability in
economic and political terms,
• refining resource distribution in the regions of Europe and European Union,
• furthering trade liberalization policies in the regions of Asia, Europe,
Oceania, and Middle East by the political route via which trade openness
influences financial development.

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ROLE OF FINANCIAL MARKETS AND

INSTITUTIONS IN ECONOMIC GROWTH:

• Financial development is:

• Thus, relationship of financial development and economic growth is a marriage

• If the direction of causality stems from financial development towards economic

OBJECTIVES OF THE STUDY

• To present a decomposed analysis of the region-wise financial sector

HYPOTHESES OF THE STUDY

SIGNIFICANCE OF THE STUDY

• Provides policymakers with comprehensive knowledge for financial and

PRIME INDICATORS OF FINANCIAL DEVELOPMENT

FINANCIAL DEVELOPMENT INDEX

Step 1: Regression Analysis

• Fixed effect model:

• Random effect model:

0.5 Average of Americas

RESULTS OF PANEL REGRESSION

Constant 2.233 1.770 2.972 3.032 2.287 2.187 2.987 3.633

TOP -0.010 0.004 0.0009 0.0009 -0.001 0.0001 -0.002 -0.0029

FID 1.645 1.079 0.303 0.375 0.880 1.048 0.991 -0.199

Constant 3.236 3.110 3.482 3.670 3.229 3.362

CAP -0.0008 -0.0003 0.009 0.008 0.008 0.005

TOP 0.002 0.0023 -0.006 -0.004 -0.0013 -0.0005

FID 0.343 0.525 0.299 0.380 0.447 1.225

• The region-wise financial reforms must aim at

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