Academic journal article IUP Journal of Applied Finance

Finance-Growth Nexus in Select Asian Countries

Academic journal article IUP Journal of Applied Finance

Finance-Growth Nexus in Select Asian Countries

Article excerpt

(ProQuest: ... denotes formulae omitted.)

Introduction

Financial development is a key to economic growth (Levine, 1997; and Graff, 2003). The relationship between economic growth and financial development has been the focus of an immense theoretical and empirical research work since the seminal work of Schumpeter (1911). However, over time, two schools of thought have developed: first, finance is a constituent of economic growth1; second, finance is an inconsequential to economic growth.2 The paper focuses on the first view, indicating the direction of causality between finance and growth.

Schumpeter (1911) argues that a well-designed financial system can contribute to economic growth by efficiently allocating financial resources. On the other hand, Robinson (1952) states that financial development is a consequence of betterments in economic growth. So, there are two hypotheses on the finance-growth nexus. First, supply-leading hypothesis, indicating finance is an instrument to economic growth (King and Levine, 1993; and Rousseau and Wachtel, 2000). Supply-leading view works in two different ways: first, by transferring resources from customary low-growth sectors to modern high-growth sectors, and second, by motivating the enterprises' response to the modern sectors. Second, demand-following view: this holds that finance actually responds to changes that happen in the real sector or 'where enterprise extends, finance follows (Robinson, 1952). The demand-following approach actually involves the measurement of growth in demand of financial services which exclusively rely on economic growth and the process of commercializing and advancement of agriculture, industry and other sectors.

Financial development, in general, represents an increase in volume of financial services of banks and other financial intermediaries as well as of financial transactions of capital markets (Graff, 2003). It includes both financial widening and financial deepening. Financial widening refers to the expansion of financial services and growth of financial institutions, while financial deepening refers to either an increase in per capita amount of financial services and institutions or an increase in the ratio of financial assets to income (Ahmed and Ansari, 1998). Financial development, by widening and diversifying the financial markets, leads to superior allocation of resources and is considered as a direct intermediate input in the production process. It raises the productivity of other factors of production (like social indicators) and profitability of producing units and thereby permits higher levels of output, income and employment.

The study aims to contribute to this existing literature by examining the nexus between financial development and economic growth in Asia, and documents the empirical evidences.

Data and Methodology

The study covers 15 Asian countries (Bangladesh, Bhutan, India, Pakistan, Sri Lanka, China, Hong Kong, Japan, South Korea, Indonesia, Malaysia, Philippines, Singapore, Thailand and Vietnam) broadly grouped into three different regions: South Asia, East Asia and Southeast Asia. The countries, under different regions, have been selected on the basis of purchasing power parity classification of the World Bank. The data are annual time series over the period 1961-2010. The data was collected from International Financial Statistics, International Monetary Fund, Washington, World Development Indicators, World Bank, Washington and CIA World Fact Book.

Financial development is a multidimensional concept, which involves a number of items. The study uses seven major items under the financial development, depending upon the availability of data and as per the relevance of economic growth in the Asian countries. The items with their modes of measurement are:

* Broad money (BRM) : This is the ratio of broad money (currency plus demand deposits and quasi-money) to GDP

* Claims on private sectors of the economy (CLP): Claims on private sectors of the economy include gross credit from the financial system to private sector. …

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