Financial Development and Economic Growth in Vietnam

Article excerpt

Abstract

By making use of a panel dataset that covers 61 provinces of Vietnam over the period 1997 to 2006, this paper examines the link between financial development and economic growth. Our analysis, which is based on endogenous growth theory, reveals that financial development has contributed to economic growth in Vietnam. We find that high ratio of credit to Gross Provincial Product (GPP) has accelerated economic growth in Vietnam. We also found a strong positive link between financial development and economic growth when alternative measures of financial development were used. The impact of foreign direct investment on economic growth will be stronger if more resources are invested in financial market development.

Keywords Financial Development * Economic Growth * Globalization * Vietnam

JEL Classification F20 * 011 * 016

1 Introduction

Financial development has contributed to impressive economic growth in a number of developing countries. In addition, it has been suggested that countries which are relatively more financially developed are better able to avoid or wimstand currency crises (Federici and Carioli 2009). Therefore, enhancing the financial development of countries with developing economies may have important positive consequences for the many organisations and individuals within such countries that are affected by economic downturns. These issues are particularly salient given the recent global financial crisis.

Generally speaking, financial development not only increases the supply of capital but, given the appropriate host-country policies, it can also facilitate technological innovation. Technological innovation contributes to human capital formation which can further enhance prospects of economic growth (in fact, it can be argued that a bi-directional causality exists between technological innovation and human capital formation). In other words, financial development can facilitate economic growth through direct as well as indirect channels.1

Endogenous growth literature [for example the work of Romer (1986), Lucas (1988, 1993)] highlights the role of financial development for long-run economic growth in developing countries. This literature suggests that financial development enhances economic growth through the impact of financial sector services on capital accumulation and technological innovation. These services include mobilization of savings, acquiring information about investments and allocation of resources, monitoring of managers and exerting corporate control and facilitation of risk reduction (Roubini and Sala-i-Martin 1992; King and Levine 1993).

On the other hand, theories of financial structure (which include the bank-based, the market-based, the financial services based and the law and finance based theories) provide alternative tools to analyse the relationship between financial structure and economic growth. For example, the bank-based theory emphasizes the positive role of commercial banks in economic development. It argues that banks can finance economic development effectively in the early stages of economic development because these banks that are unhampered by regulatory restrictions, can exploit economies of scale and scope in information gathering and processing. They can also be efficient in mobilizing resources and managing risks (Levine 2002; Beck and Levine 2004). In contrast, the market-based theory highlights the advantages of well-functioning markets in promoting successful economic performance. According to this theory, big, liquid and well-functioning markets foster growth and profit incentives, enhance corporate governance, facilitate risk management and diversification as well as customization of risk management devices (Levine 2002). The financial-services theory that is based on both the bank-based and the market-based views stresses the importance of the key financial services provided by financial systems. …