Financial Market And Growth Economics Essay

The aim of this chapter is to supply a theoretical and empirical literature reappraisal on the relationship that exists between fiscal development and economic growing and how human capital contributes to this linkage. In this chapter, the survey will first reexamine the theory of fiscal development, whereby explicating the model of fiscal system impacting growing. The following portion will concentrate on the theories of finance-growth link. Further, effects of human capital on fiscal development and economic growing will be discussed.

2.1.1 Fiscal Market and Growth

Fiscal systems have become the anchor of most economic systems around the universe. This outgrowth of fiscal system can be attributed to the being of information and dealing costs. Financial system is at that place to supply a mechanism to minimise the information and dealing costs. If information was perfect and no dealing cost was required, there would be no demand for fiscal markets and mediators to originate. Since it is non the instance in the current universe, there is a necessity for fiscal markets and mediators. Following Levine ( 1997 ) and Levine ( 2005 ) the primary maps of fiscal systems can be classified into five chief parts:

Improve allotment of resources,

Facilitate the exchange of goods and services,

Exert corporate control,

Mobilize nest eggs,

Reduce hazard

Schumpeter ( 1911 ) argued that these services provided by fiscal mediators are indispensable for technological invention and economic development. These five maps may impact economic growing through two major channels, that is the capital accretion and the technological invention channel ( largely referred to as entire factor productiveness channel ) . In growing theoretical accounts back uping capital accretion, fiscal systems can advance growing by heightening the rate of capital formation, either by increasing salvaging rates or by bettering the allotment of nest eggs from possible investors to those in deficiency of resources. Allen and Gale ( 2001 ) argue that fiscal systems are important to the allotment of resources in a modern economic system. On the other manus, entire factor productiveness channel emphasizes the ability of fiscal sector to change the rate of technological invention.

The figure below illustrates the theoretical position of how the presence of market clashs motivates the outgrowth of stock markets and fiscal mediators and how the being of fiscal system supports growing.

Market Clashs:

Information costs

Transaction costs

Stock markets and fiscal mediators

Primary fiscal maps:

Facilitate exchange

Allocate resources

Mobilize nest eggs

Exert corporate control

Reduce hazard

Channelss to Growth:

Capital accretion

Technical invention

Economic Growth

Figure 1: A Theoretical Approach to Finance and Economic Growth

Beginning: Levine ( 1997 )

The wide thought of the finance- growing link is that the maps mentioned above enhance efficiency and accordingly, better economic growing. The contrary besides holds, that is, a fiscal crisis state of affairs has a negative influence on economic growing for the ground that fiscal intermediation lessenings[ 1 ]. It is to be noted that non all fiscal systems work expeditiously and some are better in supplying the maps mentioned above than others, in other words, there is a difference in the development of different fiscal systems. This is supported by a statement of Levine ( 2004 ) where he states that ‘Financial development occurs when fiscal instruments, markets and mediators ameliorate – though do non needfully extinguish – the effects of information, enforcement and minutess costs and hence do a correspondingly better occupation at supplying the five fiscal maps. ‘ Bencivenga and Smith ( 1991 ) are the first to decently analyze the finance-growth relation in an endogenous growing theoretical account whereby reasoning that under certain conditions, intermediation by Bankss consequences in high growing rates. With debut of fiscal intermediation, nest eggs becomes of import thereby assisting the economic system. However, their theoretical account focuses merely on a narrow field, so more research is needed. Along with this survey, Jayaratne and Strahan ( 1996 ) concluded that there are two chief links between fiscal development and growing. First, a better developed fiscal system makes nest eggs more attractive and therefore increasing sum of nest eggs. Second, the system becomes more efficient when being mature. Both effects can act upon economic growing positively.

2.1.2 Relationship between Financial Development and Economic Growth

( I ) Finance Led Growth Theories

In the traditional development economic sciences, there exist two distinguishable positions of the finance-growth link. Back in 1911 Joseph Schumpeter argued that fiscal development induces economic growing. He discussed that through the services that fiscal mediators offer are indispensable drivers of invention and growing. Financial intermediaries enable this technological invention ( King, Levine, 1993 ) . Hicks ( 1969 ) besides noticed that fiscal establishments facilitate growing, though he focused on capital formation. Harmonizing to Hicks the industrial revolution in England was chiefly caused by the capital market betterments that moderated liquidness hazard ( Levine, 1997 ) .

The above general position was besides shared by bookmans like Goldsmith ( 1969 ) , McKinnon ( 1973 ) and Shaw ( 1973 ) , who besides opted for the practical map of fiscal services. Goldsmith ( 1969 ) assumed that the size of a fiscal system is linked with the supply and quality of fiscal intermediation and his analysis on 35 sample states proved a positive correlativity between the fiscal development and economic growing. McKinnon ( 1973 ) and Shaw ( 1973 ) suggested that province engagement in the development of fiscal systems can be an obstruction for economic growing whereby involvement rate ceiling, high modesty demands, directed recognition policies and prejudiced revenue enhancement of fiscal mediators influence negatively the rate of economic growing. Hence, both showed fiscal liberalization and development do speed up the rate of economic growing. This position was further seconded by King and Levine ( 1993 ) ; Pagano ( 1993 ) ; Fry ( 1995 ) ; Zervos and Levine ( 1996, 1999 ) ; Christopoulos ( 2004 ) ; Manoj and Kamat ( 2007 ) ; Hasan, Watchel and Zhou ( 2008 ) and Seetanah ( 2009 ) where all believed that fiscal development is a accelerator for economic growing.

( two ) Growth Led Finance Theories

The alternate position suggests that economic growing is the major drive force behind the development of the fiscal sector. This thought is really much stressed in the work of Robinson ( 1952 ) . Harmonizing to him, as an economic system grows, more fiscal establishments, fiscal merchandises and services emerge in markets in response to a higher demand for fiscal services. Further, the Patrick ‘s hypothesis ( 1966 ) was introduced with the supply taking and demand followers, which is of import to find the finance-growth link. The demand following position explains the demand for fiscal services is dependent upon growing and modernisation of chief sectors. Therefore, modern fiscal establishments, fiscal assets and liabilities are encouraged in response to the demand of these services by investors in the existent economic system. Therefore, the more rapid growing of existent national income, the greater will be the demand by endeavors for external financess ( the nest eggs of others ) and hence fiscal intermediation. Besides, with a given aggregative growing rate, the greater the discrepancy in the growing rates among different sectors or industries, the greater will be the demand for fiscal intermediation to reassign salvaging from slow-growing to aggressive industries. In this instance, an enlargement of the fiscal system is induced because of existent economic growing. The following arm of the theory is the supply taking position by. The supply- prima hypothesis has two maps. To reassign resources from the traditional low-growth sector to the modern high-growth sector is first, and secondly, to advance a executable response among investors in these modern sectors. Therefore, fiscal services from the system excite the demand for these services in modern and developing sectors.

( three ) Causal relationship between finance and growing

The development of new theories of endogenous economic growing has given a new range for fiscal intermediation in act uponing economic public presentation ( Liu, Shu, 2002 ) . Therefore, fiscal markets have strong impact on existent economic activity. Surely, Hermes ( 1994 ) argues that fiscal liberalisation theory and the new growing theories assume that fiscal developments lead to economic growing. However, Murinde and Eng ( 1994 ) , Luintel and Khan ( 1999 ) argue that a member of endogenous growing theoretical accounts show the causal relation between fiscal development and economic growing.

2.1.3 Human Capital on finance-growth nexus

Human capital influences the finance-growth nexus. Levine and Zervos ( 1998 ) indicate that human capital is of import for finance-growth nexus. Outrivelle ( 1999 ) further back up the position that human capital do act upon the fiscal development and growing relationship by demoing that steps used for human capital extremely positively correlative with that of finance- growing nexus. Human capital is of importance to the efficiency with which nest eggs are distributed. Beck, Levine and Loayza ( 2000 ) survey whether fiscal development is positively linked with Entire Factor Productivity ( TFP ) , physical capital accretion and private nest eggs rates and economic growing. They conclude that there exists a positive nexus between TFP and fiscal development and besides human capital accretion does bring forth similar consequences as TFP. Besides, Benhabib and Spiegel ( 2000 ) find that fiscal development has a positive influence on TFP growing and rate of human capital accretion. In 2002, Evans, Green and Murinde include human capital steps and fiscal development steps in their survey on the connexion of both with economic growing and they find that fiscal development on its ain has a positive consequence on economic growing and human capital besides have a positive important influence.

Furthermore, economic growing is positively influenced in states with a higher degree of human capital in their economic system, since the distribution of fiscal merchandises is more efficient. It is anticipated that the interaction between finance and human capital positively influence economic growing. Likewise, in one of the decision of Calderon and Lui ( 2003 ) , it is found that economic growing is influenced by fiscal development through capital accretion and productiveness growing. They refer to productivity growing as ‘improvements in engineering ‘ , which can be seen as a more efficient distribution of nest eggs. Hereby, efficient usage of nest eggs can be influenced by the sum of human capital among other linkages. Additionally, economic experts like De Gregorio ( 1992 & A ; 1996 ) and Papagni ( 2006 ) analyzed the liquidness restraints on human capital accretion by reasoning that borrowing restraints increase aggregative nest eggs taking to decrease of human capital therefore holding negative effects on the economic system. De Gregorio ( 1992 ) states that ‘ if families borrow to finance accretion of human capital, so the nest eggs rate will lift in the long-term but will take down the productiveness of investing in the short-run. Papagni ( 2006 ) argues otherwise that if liquidness restraints of young persons are reduced by their parents ‘ averment of loan refund with their income, so human capital can be enhanced and so is growing. Thus, human capital is seen as an of import channel in the finance-growth relation.


Having reviewed the important theories underlying the relationship between fiscal development and economic growing and the consequence of human capital on fiscal development and economic growing connexion, it is of import to reexamine some chief researches that have been done in the field. The empirical analysis will be divided in two chief parts. The first portion will be subdivided harmonizing to different degree of industrialisation and developed an economic system is, demoing whether economic systems follow a supply-leading relationship between fiscal development and growing or a demand-leading relationship. The 2nd portion will farther reexamine how the human capital has affect economic systems and its interaction on fiscal development and growing nexus. Finally, there will be a subdivision reasoning with a few comments.

2.2.1 Finance-Growth Link

The nexus of fiscal development and economic growing will be viewed harmonizing to different degree of economic systems.

2.2.1. A Studies of developed states

Researchs based on the finance-growth link in developed states find a positive important relationship. Table 1 nowadayss a reappraisal of relevant surveies demoing this relationship.

[ TABLE 1 ]

Table 1 provides a sum-up of some empirical surveies that have been conducted sing relationship between growing and fiscal development. Surveies affecting merely developed economic systems are explained as follows. Vazakidis and Adamopoulos ( 2009 ) and Ghirmay ( 2006 ) used clip series to analyze the nexus between fiscal development and growing on developed economic systems where they found that a supply-leading hypothesis is favored but for Greece, Vazakidis et Al. found that the relationship runs from economic growing to fiscal development, through an industrial production based. Kemal et Al. ( 2004 ) through panel causality found direct finance is significantly and positively related to developed economic systems ‘ growing but the consequences were non conclusive across states.

Besides, Rousseau and Watchel ( 1998 ) conducted his surveies by a vector autoregressive theoretical account merely in developed states whereby he found a one-way causality that is finance causes growing. Furthermore, Levine ( 1998 ) showed that states with a good legal system protecting creditors favour a robust and positive impact on the economic growing. Rajan and Zingales ( 1998 ) found that industries that depend chiefly on external beginning of finance grow faster in economic systems with higher fiscal and industrialised degree. However, Neusser and Kugler ( 1996 ) , analyzing 13 OECD states found that in most developed states economic growing promotes fiscal development except in USA, Japan and Germany where the contrary causality was found.

To farther continue, surveies affecting both developed and developing economic systems as shown from the empirical grounds in Table 1 indicate how fiscal development and economic growing are related and how fiscal mediators foster growing. Surveies utilizing cross-sectional arrested development theoretical account, like King and Levine ( 1993 degree Celsius ) and De Gregorio and Guidotti ( 1995 ) found that all the indexs of fiscal development were significantly and positively related to the economic growing in developed and developing states. Levine et Al. ( 2000 ) utilizing the generalised methods of minute support their findings. Besides, Rioja and Valev ( 2004 ) modeled their work through generalized method of minutes GMM on 74 states and they found that fiscal development significantly affects growing in center and high economic systems whereas in low economic systems, finance may hold a negative consequence on growing. Calderon and Lui ( 2003 ) used a sample of both developed and developing states in order to look into the finance-growth nexus by utilizing Geweke decomposition trial. They found that fiscal development has a greater consequence on less developed states than in more developed 1s.

Goldsmith ( 1969 ) in his survey of 35 developed and developing states calculated the fiscal intermediation ratio, that is, ratio of fiscal instrument to existent wealth for each state and compared them to the existent development. The consequences obtained were that fiscal development is a requirement with existent development. Further surveies utilizing both developed and developing states as their sample, such as Cameron R. ( 1972 ) positively concluded the function of fiscal establishments in development. Jung ( 1986 ) , Xu ( 2000 ) and Apergis et Al. ( 2007 ) show that the supply-leading hypothesis is supported in low-income economic systems while the demand-leading hypothesis is supported in high/middle-income economic systems. These writers found that finance caused economic growing more often in developing states than in developed 1s and in developed states, growing caused fiscal development more frequently. In following the similar line, Deidda and Fattouh ( 2002 ) and Ram ( 1999 ) , utilizing a sample of both developed and developing states concluded a positive relationship between finance and growing merely in high-income states, with a causal consequence from growing to finance.

2.2.1. B Studies of developing states

Table 2 below summarises several relevant surveies demoing the relationship that exists between finance and growing in developing states.

[ TABLE 2 ]

Ndikumana and Allen ( 2000 ) modeled their work through pooled cross-sectional arrested development on 12 Sub-saharan African states. They concluded that there exists merely a positive relationship between fiscal development and growing when the ratio of liquid liability to GDP is used. Trabelsi ( 2002 ) conducted his survey on 69 developing counties utilizing both cross-sectional and pooled cross-section time-series arrested developments. They found that the development of fiscal sector merely seems to impact growing with cross-sectional arrested development while panel informations analyses do non supply any empirical support for the growth-finance relationship. Additionally, Jeanneney Hua and Liang ( 2006 ) examined the relationship between fiscal development and productiveness growing in China through GMM for panel informations analysis. The consequences obtained coincided with the theories demoing that fiscal development significantly contributes to China ‘s productiveness growing through efficiency. Ndikumana ( 2005 ) further confirms that fiscal development facilitates domestic investing to the extent that it is accompanied by an addition in the supply of financess to investors.

Assorted surveies from empirical Table 2 such as Odedokun ( 1996 ) KhalifaGhali ( 1999 ) , Agbetsiafa ( 2003 ) , Ghirmay ( 2004 ) , Christopoulos and Tsianos ( 2004 ) and Habibullah and Eng ( 2006 ) conducted their surveies merely on developing states. They found that in about all the developing states, fiscal development contributes to economic growing significantly. In the same line, Nasri and Mouawiya ( 2005 ) investigated the linkage between fiscal development and economic growing both in short and long tally through panel co-integration on Middle East states. The writers found that in long-run, fiscal development is related to some extent and in short-run, the panel causality trials indicate that existent growing causes alterations in fiscal development. On the other manus, Khan and Qayyum ( 2006 ) applied a edge proving attack to co-integration within the model of Autoregressive Distributed Lag ( ARDL ) to look into the joint impact of trade liberalisation and FD on growing in Pakistan and the consequences show that there is a relationship between existent GDP, trade liberalisation, fiscal development and the existent involvement rate in the long tally.

Using further the abovementioned methodological analysiss, surveies in Table 2 above provide assorted consequences. Some surveies conducted in developing states support some grounds of a supply-leading form, while others merely back up a demand-following form. Demetriades and Hussein

( 1996 ) , Habibullah ( 1999 ) , Odhiambo ( 2007 ) and Boulila and Trabelsi ( 2004 ) conducted their surveies merely on developing states and supported small grounds that finance causes growing whereby most of the clip, they found strong and important grounds that growing causes finance. Other surveies, such as Waqabaca ( 2004 ) , revealed that there is a important relationship between fiscal development and growing with causality running from growing to finance. Besides, Yousif ( 2002 ) showed that some developing states follow the supply-leading and some follow demand-following form but concluded that they are non every bit important as the bidirectional 1. Luintel and Khan ( 1999 ) conducted their survey on 10 developing states whereby they merely found bi-directional causality for all the states in their sample.

Furthermore, Demetriades and Luintel ( 1996 ) focused on India and they found a bipartisan causal relationship between fiscal development and economic growing. Using the same information and theoretical account in Tanzania, Odhiambo ( 2005 ) suggested that the causal relationship between fiscal development and economic growing depends on what index is being used. When the ratio of wide money to GDP is used, fiscal development leads to growing and when the two other indexs of fiscal development, that is, ratio of currency to GDP and ratio of Bankss claims on private sector to GDP, are used, bidirectional causality prevails. More late, Zang and Kim ( 2007 ) examined the existent causality between fiscal development and economic growing in developing states and they found no statistically important and positive grounds of the causal relationship between fiscal development and economic growing.

Human Capital in Financial Development and Economic Growth Relation

First, a reappraisal over the relation of human capital with economic growing will be carried out. Lucas ( 1988 ) concludes that human capital accretion is an of import factor of economic growing. He states that the difference in life criterions is influenced to a big extent by fluctuation in human capital. Besides, Mankiw, Romer and Weil ( 1992 ) find that human capital is an of import variable in an augmented Solow growing theoretical account accounting for the difference in income between states. In 1995, Graff observe the function of human capital on economic growing and concluded that the accretion of human capital, physical capital and technological advancement all to be important determiners of the growing procedure. Barro and Jongh-Wa ( 2000 ) analyze the impact of human capital, whereby placeholder used is the highest grade of schooling on economic growing by utilizing panel informations analysis. They conclude that human capital positively influenced growing. However, it has been found that there is a strong principle for this relation in favour of authorities intercession because puting in human capital will be affected by governmental policies. More exactly, authorities policies affect the instruction system and preparations, which are of import in finding the procedure of growing of the economic system.

For this survey, it is of import to travel deeper and look at the consequence of human capital in the finance-growth relation. In 1992, De Gregorio, taking into consideration the liquidness restraints, provinces that borrowing human capital accretion to finance, so in long-term, salvaging rate will be raised with a lowering of the productiveness of investing in the short-term. Therefore, he argues that a low degree of human capital reduces overall nest eggs in the economic system and increases domestic recognition to the private sector to provide for instruction system. Sing the interaction of human capital in finance-growth nexus, Outrivelle ( 1999 ) performs his trial on 57 developing states and he shows that there exist a positive correlativity between steps of fiscal development and human capital steps. Further, the consequences of additive arrested development analysis confirmed that steps of fiscal development are positively correlated with existent GDP per capita and with steps of human capital development.

Furthermore, school registration variable used as human capital variable by Beck, Levine and Loayza ( 2000 ) happen two out of three arrested developments, positive and important nexus with school registration and fiscal development variables. Benhabib and Spiegel ( 2000 ) conduct a research on the channels in the finance-growth field. They study whether fiscal development has a positive influence on physical capital, as measured by investings and human capital, as measured by mean old ages of schooling in the work force. They find positive consequences for investings and conclude that physical capital is an of import channel to associate finance with growing. However, less grounds provide for human capital as human capital positively correlative with merely one fiscal variable, that is, with the ratio of bank sedimentation assts to cardinal bank assets. Therefore, they conclude that fiscal development is channeled by physical and human capital.

Another survey, Evans et Al. ( 2002 ) utilize a trans-log production model in a panel of 82 states for 21 old ages so as to look into both the influence of fiscal development and human capital on economic growing. They find that there exists positive relationship between money and human capital and besides find that both money and human capital brand important part to growing, irrespective of the step of pecuniary factors or that of human capital is taken. Evans et Al. besides highlight that their consequences back up much more the hypotheses of McKinnon and Shaw theories instead than the endogenous growing theories. Hence, reasoning, that a developed fiscal system is an indispensable complement to manpower development in the growing procedure. Recently, in Hakeem and Oluitan ( 2012 ) , this causal relationship has been studied over South Africa for last 40years by utilizing clip series analysis. They find a strong relationship between fiscal development and existent economic growing and besides find that secondary registration rate which was a placeholder used for human capital does act upon the finance and growing nexus.

2.3 Decision

This chapter reviewed both theoretical and empirical literature chiefly on the interaction of human capital on fiscal development and economic growing nexus. The first subdivision discussed the theoretical relationship while the 2nd subdivision reviewed the empirical literature harmonizing to different degree of economic systems. The empirical reappraisal shows the impact of sample size, pick of states, methodological analysis and variables of the consequences. It besides supported different accounts given in the literature. Surveies utilizing cross-sectional arrested developments have failed in explicating the existent way of causality between fiscal development and economic growing. On the other manus, surveies that used clip series techniques have largely focused on analyzing the causality between fiscal development and economic growing and they are more recent than surveies utilizing cross-sectional arrested development. In general, the position that in developing states, finance causes growing in the earlier phases of economic development and in developed states, growing causes fiscal development. It has besides found that important figure of surveies detected a bipartisan causal relationship. Sing, human capital on finance-growth linkage, it positively affect this relationship. Based on the empirical reappraisals, it can be noted that the consequences do non supply a full and clear position on the specific human capital in the finance-growth link. However, due to expected importance of human capital as a accelerator in the finance-growth relationship, this survey includes human capital in its theoretical account.

The following chapter will construct on the background and development of the Mauritius. It will help in placing variables suited for these states which will be included in theoretical account specified in Chapter Four.