Relationship between financial development and economic growth: panel data analysis of 22 developing countries

Abstract

In recent years, many researchers have taken into account the causal connection between financial development and economic growth due to the important role of financial development in the process of achieving the higher economic growth. To investigate the causal relationship between financial development and economic growth in twenty two developing countries in different regions from 1990 to 2011, we apply both Generalized method of moment with instrumental variable approach and Ordinary least square technique to examine how determinants of financial development impact on economic growth and how the determinants of economic growth contribute to develop finance system. We find that there is a two-way positive impact between financial development and economic growth in selected developing countries. We also find that the variable components such as the ratio of broad money to GDP, the ratio of credit offered by bank to private sector to GDP, the ratio of gross domestic savings to GDP and the ratio of domestic credit to the private sector to GDP play an important role in explaining financial development. Furthermore, foreign direct investment, general government consumption and trade openness are important factors in accounting for growth rate of GDP per capita. We find out that the EXPORT is significantly negative impact on economic growth. This result is consistent with the argument that export specialization in developing countries may not benefit the economic growth. Finally, taking the advantage of positive relationship between financial and economic development in developing countries, it is suggested that Vietnam needs to strengthen its financial system in the context of the integration into the world economy. Vietnam should provide the right incentives to promote the financial sector that will enable it to have high economic growth.