Aspects of Financial Development and Manufacturing Growth and Size: Which Matter? Sarah Salvador Daway-Ducanes Maria Socorro Gochoco-Bautista University of the Philippines School of Economics (UPSE) FD and Manufacturing Growth 1 / 33
Introduction Renewed interest in the …nancial development-growth nexus in the wake of the global …nancial crisis Polarized theoretical arguments and empirical evidence Positive link Negative link (UPSE) FD and Manufacturing Growth 2 / 33
Introduction Positive Link Financial intermediaries, in endogenous growth theory: Facilitate savings and capital mobilization towards the most productive activities (Bagehot, 1873; Schumpeter, 1912; Hicks, 1969; McKinnon, 1973; and Shaw, 1973) Help mitigate information asymmetry problems by Achieving transactions cost-minimizing economies of scale Diversifying and pooling of risks Greenwood and Jovanovic (1990), Levine (1998), Levine (1999) That enable technological and process innovations and overall economic development Positive FD-growth link: King and Levine (1993a, 1993b), Rajan and Zingales, 1998; Beck, Levine and Loayza, 2000; Levine, Loayza and Beck, 2000; Beck and Levine (2004), Loayza and Ranciere (2006); Beck et al. (2007); Beck and Demirguc-Kunt (2008); and Saci et al. (2009) (UPSE) FD and Manufacturing Growth 3 / 33
Introduction Negative Link Credit surges often precede …nancial/banking crises (Beck and Levine, 2004) Erosion of …nancial institutions, which in turn, raises the likelihood of growth-inhibiting …nancial crises (Rogo¤, 2009). Sample of economies with less developed …nancial sectors over the period 1960 to 2004 (Rousseau and Wachtel, 2011) Sub-sample of 12 Latin American countries from 1960 to 1989 (De Gregorio and Guidotti, 1995) Both using dynamic panel data estimators Lack of …nancial scale often attributable to the existence of weak institutions and market failures that are more pronounced in developing economies (Sutton and Jenkins, 2007). (UPSE) FD and Manufacturing Growth 4 / 33
Introduction Negative Link Financial repression, weak …nancial institutions and ine¢ciencies in credit allocation that predominantly favor public enterprises (Ben Naceur and Ghazaouani, 2007; Ayadi et al., 2013). Negative short-run (annual) e¤ect of private credit expansion on growth: 30 developing economies over the period 1988-2001, using a two-step system general method of moments (SGMM) (Saci et al.,2009) 11 southern and eastern mediterannean countries, using dynamic panel GMM methods (Ben Naceur and Ghazaouani, 2007) Developed and developing Mediterranean countries over the period 1970-2009 (Ayadi et al., 2013) (UPSE) FD and Manufacturing Growth 5 / 33
Introduction Size Matters Existence of nonlinearities in the …nancial development-growth nexus For less developed …nancial systems: positive e¤ect vanishes (Deida and Fattouh, 2002; and Rioja and Valev, 2004) For middle-income and high-income economies over the period 1960-2010 (Arcand et al., 2011) Existence of diminishing returns to …nancial expansion when private credit (as % of GDP) is higher than the 80-100% range Consistent with Easterly, Islam and Stiglitz (2000): range where greater …nancial depth starts increasing volatility of growth Robust to controls for macroeconomic instability, banking crises, and institutional quality. A case of “too much …nance” (UPSE) FD and Manufacturing Growth 6 / 33
Bank-Based vs. Market-Based FD Arguments for bank-based systems In highly liquid systems, information asymmetry problems are exacerbated (due to lax accountability in corporate management), resulting in an ine¢cient allocation of savings Banks mitigate market failures due to their long-term relationships with …rms Arguments for market-based systems Large banks encourage conservative investment projects, while extracting large rents from …rms � ! low pro…tability � ! less incentive to invest in productivity-enhancing technologies and innovations Financial markets provide a larger set or …nancial instruments, allowing better customization of risk management techniques, unlike in standardized bank-based systems Should develop both, since they provide complementary …nancial services to the economy (La Porta, et al., 1997; Levine (1998, 1999b); Khan and Senhadji, 2000) (UPSE) FD and Manufacturing Growth 7 / 33
This Paper Seeks to answer the question, "Which aspects of …nancial development are bene…cial to manufacturing growth and manufacturing size in developing economies?" Employs Blundell and Bond’s (1998) and Windmeijer’s (2005) two-step system GMM On an unbalanced panel dataset of 108-113 economies from the World Development Indicators Over six periods of …ve-year averages from 1997 to 2016 Using the new IMF …nancial indicators dataset, which gives a broad-based measure of FD Focusing on the FD-manufacturing growth and size links in developing economies (UPSE) FD and Manufacturing Growth 8 / 33
Preview of Results The usual indicators of …nancial development, i.e., private credit (% GDP) and bank credit (% GDP) do not have statistically signi…cant e¤ects on manufacturing growth and size. For about 50-99% of the economies in the sample, the …nancial scale levels are considerably below the minimum e¢ciency scales. Size matters: the …nancial sector must attain a minimum e¢ciency scale before credit and liquidity expansion can bene…t the economy, indicating a case of “too little” …nance. (UPSE) FD and Manufacturing Growth 9 / 33
Preview of Results (UPSE) FD and Manufacturing Growth 10 / 33
Preview of Results Using the IMF …nancial development indicators (broad-based measure of …nancial development): On manufacturing growth: …nancial market and institutional depth, access, e¢ciency have positive and signi…cant overall marginal e¤ects On manufacturing size : …nancial market and institutional depth and …nancial market access and e¢ciency have positive and signi…cant marginal e¤ects; …nancial institutional access has a negative and signi…cant marginal e¤ect; …nancial market e¢ciency has no signi…cant e¤ect How …nancial development is measured matters! (UPSE) FD and Manufacturing Growth 11 / 33
Model Using Blundell and Bond’s (1998) and Windmeijer’s (2005) two-step system GMM (SGMM) , we estimate: y it = α FD it + β FD 2 it + FD it DevEcon + γ X it + δ Z it + η i + ε it , where y it is the annual growth rate of manufacturing or manufacturing value added’s share in GDP in country i in period t ; FD it represents the …nancial development indicator; DevEcon is a dummy variable that is equal to one if country i has a real GNI per capita of not more than $10,000 in 1992; X it is a vector containing predetermined and endogenous regressors, which include the lagged value(s) of the dependent variable; Z it is a vector of strictly exogenous regressors; η i is the unobserved …xed-individual e¤ect; and ε it is the error term. (UPSE) FD and Manufacturing Growth 12 / 33
Model Two-step SGMM has the following advantages: Allows the treatment of regressor endogeneity, using the lagged values of the dependent variable and the covariates as instruments Mitigates the Nickell bias: appropriate for big N small T datasets Generates more precise and more e¢cient estimates, mitigating the …nite-sample bias Is more appropriate for dealing with variables that are or close to ‘random walk’ Information loss due to di¤erencing in unbalanced datasets is less severe (UPSE) FD and Manufacturing Growth 13 / 33
Financial Development Indicators Private credit – credit extended to the private sector by the …nancial sector (% GDP); most common measure: used in Beck et al. (2000); Edison et al. (2002); Levine (2000); Favara (2003); Loayza and Ranciere (2006); Beck et al. (2007); Beck and Demirgüç-Kunt (2008); Saci et al. (2009) Bank credit – credit extended by banks to the private sector (% GDP); used in Beck and Levine (2004) and Levine and Zervos (2004) (UPSE) FD and Manufacturing Growth 14 / 33
IMF Financial Development Indicators Source: Svirydzenka (2016) (UPSE) FD and Manufacturing Growth 15 / 33
IMF Financial Development Indicators Financial institutions depth Private credit (% GDP) Pension fund assets (% GDP) Mutual fund assets (% GDP) Insurance premiums (% GDP) Financial markets depth Stock market capitalization (% GDP) – measures size of the stock market Stocks traded (% GDP) – measures how active the market is International debt securities of government (% GDP) Total debt securities of …nancial corporation (% GDP) Total debt securities of non…nancial corporation (% GDP) (UPSE) FD and Manufacturing Growth 16 / 33
IMF Financial Development Indicators Financial institutions access Bank branches per 100,000 adults ATMs per 100,000 adults Financial markets access Percent of market capitalization outside of the top 10 largest companies (proxy of stock markets access) Total number of issuers of debt per 100,000 adults (proxy of bond market access) (UPSE) FD and Manufacturing Growth 17 / 33
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