Skip to main content

Advertisement

SpringerLink
Log in

The tipping point of financial development? – evidence from OECD countries

  • Original Paper
  • Published:
International Economics and Economic Policy Aims and scope Submit manuscript

Abstract

This study estimates the tipping points of financial development in the finance – growth dynamics in the case of OECD countries as they experience considerably higher levels of financial development. Using a unique balanced panel data set of 31 years from 1983 to 2013 for 27 OECD countries, we provide new evidence on the presence of nonlinearity as there is an inverted U-shaped relationship between finance and growth in the long run. The results show that there exists a tipping point of the finance-growth relationship estimated at 141.6% of GDP. We find that surpassing the threshold level results in deceleration of economic growth as excess finance is undesirable. Based on the panel Granger causality test results, we show that financial development should be associated with optimal growth performance. Our findings for OECD countries provide some useful inferences to the emerging and developing economies in designing their financial development strategies.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1
Fig. 2
Fig. 3
Fig. 4

Similar content being viewed by others

Notes

  1. The Organization for Economic Cooperation and Development (OECD) is a unique forum of 34 democractic nations that promote market economies to promote economic growth, prosperity, and sustainable development. According to the OECD, the member countries account for 63% of world GDP, three-quarters of world trade, 95% of world official development assistance, over half of the world’s energy consumption, and 18% of the world’s population.

  2. Most studies use the log of financial development and therefore allow for a non-linear relationship between financial development and economic growth. However, they do not include higher polynomial terms and thus they do not allow for a non-monotonic relationship between these two variables.

  3. For a detailed and illuminating discussion of the concept and process of financial development per se, see de la Torre et al. (2011).

  4. Our attempts to include life expectancy, government expenditure and education (specifically, secondary school enrolment) resulted in too many missing observations.

  5. A source of concern when estimating fixed effect model is that the limited within-country variability of the data tends to amplify the attenuation bias brought about by the presence of measurement errors. Our variables of interest, however, do not display substantial cross-country and within-country variation.

  6. Among the two specification tests, the first is the Sargan test of over-identifying restrictions, which tests the overall validity of the instruments by analyzing the sample analog of the moment conditions used in the estimation process. The second test examines the hypothesis that the error term εi,t is not serially correlated. In both the difference regression and the system difference-level regression we test whether the differenced error term is second-order serially correlated (by construction, the differenced error term is probably first-order serially correlated even if the original error term is not).

  7. More evidence in this direction is available with Levine et al. (2000) and Beck et al. (2000) who use different types of instruments and econometric techniques to identify the presence of a causal relationship going from finance to growth.

  8. We report the thresholds at which financial development starts having a negative effect on growth.

  9. Easterly et al. (2000), on a related subject, observe that greater credit or a deeper financial system is significantly associated with less volatility of growth, but the relationship appears also nonlinear.

References

  • Acemoglu D, Zilibotti F (1997) Was prometheus unbound by chance? Risk, diversification, and growth. J Political Econ 105(4):709–751

    Google Scholar 

  • Adam CS, Bevan DL (2005) Fiscal deficits and growth in developing countries. J Public Econ 89:571–597

    Google Scholar 

  • Aghion P, Howitt P, Mayer-Foulkes D (2005) The effect of financial development on convergence: theory and evidence. Q J Econ 120:173–222

    Google Scholar 

  • Aghion P, Angeletos GM, Banerjee A, Manova K (2010) Volatility and growth: credit constraints and the composition of investment. J Monet Econ 57:246–265

    Google Scholar 

  • Andrews DWK, Ploberger W (1996) Testing for serial correlation against an ARMA(1, 1,) process. J Am Stat Assoc 91:1331–1342

    Google Scholar 

  • Ang JB, McKibbin WJ (2007) Financial liberalization, financial sector development and growth: evidence from Malaysia. J Dev Econ 84(1):215–233

    Google Scholar 

  • Arcand, J. L., Berkes, E., Panizza, U., 2012. Too much finance? IMF Working Paper 12/161

  • Arellano M, Bond S (1991) Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. Rev Econ Stud 58(2):277–297

    Google Scholar 

  • Arellano M, Bover O (1995) Another look at the instrumental variable estimation of error-components models. J Econ 68:29–52

    Google Scholar 

  • Baltagi B (2008) Econometric analysis of panel data. John Wiley and Sons, Chichester

    Google Scholar 

  • Barro RJ (1991) Economic growth in a cross-section of countries. Q J Econ 106:407–443

    Google Scholar 

  • Barro R, Sala-i-Martin X (2004) Economic growth, second edn. Press, MIT

  • Beck T, Levine R, Loayza N (2000) Finance and the sources of growth. J Financ Econ 58(1):261–300

    Google Scholar 

  • Beck T, Degryse H, Kneer C (2012a) Is more finance better? Disentangling intermediation and size effects of financial systems, Center for Economic Research, Discussion Paper No. 2012–060, Tilburg University

  • Beck T, Buyukkaraback B, Rioja FK, Valev NT (2012b) Who gets the credit? And does it matter? Household vs firm lending across countries. BE J Macroecon 12

  • Bencivenga VR, Smith BD (1991) Financial intermediation and endogenous growth. Rev Econ Stud 58(2):195–209

    Google Scholar 

  • Blackburn K, Hung V (1998) A theory of financial intermediation and growth. Economica 65:107–124

    Google Scholar 

  • Blundell R, Bond S (1998) Initial conditions and moment restrictions in dynamic panel data models. J Econ 87(1):115–143

    Google Scholar 

  • Breitung J (2000)The local power of some unit root tests for panel data. In: Baltagi, B.H.(Ed.), Nonstationary Panels, Panel Cointegration, and Dynamic Panels. Adv Econ 15:161–178

  • Breitung J (2005) A parametric approach to the estimation of cointegration vectors in panel data. Econ Rev 24(2):151–173

    Google Scholar 

  • Breusch T, Pagan A (1980) The Lagrange multiplier test and its application to model specifications in econometrics. Rev Econ Stud 47:239–253

    Google Scholar 

  • Calderon C, Liu L (2003) The direction of causality between financial development and economic growth. J Dev Econ 72:321–334

    Google Scholar 

  • Campos NF, Kinoshita Y (2008) Foreign direct investment and structural reforms: evidence from Eastern Europe and Latin America. International Monetary Fund, IMF Institute, Washington, DC

    Google Scholar 

  • Cecchetti G, Kharroubi E (2012) Reassessing the impact of finance on growth. BIS Working Papers No. 381, Bank for International Settlements

  • Christopoulos DK, Tsionas EG (2004) Financial development and economic growth: evidence from panel unit root and cointegration tests. J Dev Econ 73(1):55–74

    Google Scholar 

  • Chudik A, Mohaddes K, Pesaran MH, Raissi M (2015). Is there a debt-threshold effect on output growth. IMF Working Paper No. 15/197

  • Dawson PJ (2010) Financial development and economic growth: a panel approach. Appl Econ Lett 17(8):741–745

    Google Scholar 

  • de la Torre A, Ize A, Schmukler S (2011) Financial development in Latin America and the Caribbean: the road ahead. World Bank, Washington, DC

    Google Scholar 

  • Deidda L (2006) Interaction between economic and financial development. J Monet Econ 53:233–248

    Google Scholar 

  • Deidda L, Fattouh B (2002) Nonlinearity between finance and growth. Econ Lett 74:339–345

    Google Scholar 

  • Demetriades P, Hussein K (1996) Does financial development cause economic growth? Evidence for 16 countries. J Dev Econ 51:387–411

    Google Scholar 

  • Demetriades P, Law SH (2006) Finance, institutions and economic growth. Int J Financ Econ 11(3):245–260

    Google Scholar 

  • Easterly W, Rebelo S (1993) Fiscal policy and economic growth: an empirical investigation. J Monet Econ 32(3):417–458

    Google Scholar 

  • Easterly, W., Islam, R., and Stiglitz, J. 2000. Shaken and stirred, explaining growth volatility," annual Bank conference on development economics. World Bank, Washington D.C.

  • Favara G (2003) An empirical reassessment of the relationship between finance and growth. IMF Working Paper No. 03/123

  • Fry MJ (1997) In favor of financial liberalization. Econ J 107(442):754–770

    Google Scholar 

  • Gennaioli N, Shleifer A, Vishny RW (2010) Neglected risks, financial innovation, and financial fragility. NBER Working Papers 16068

  • George A, Marbuah G, Mensah JT (2013) Financial development and economic growth in Ghana: does the measure of financial development matter? Review of Development Finance 3:192–203

    Google Scholar 

  • Goldsmith RW (1969) Financial structure and development. Yale University Press, New Haven

    Google Scholar 

  • Greenwood J, Jovanovic B (1990) Financial development, growth, and the distribution of income. London, Ont., Canada: Dept. of Economics, Social Science Centre, University of Western Ontario

  • Gurley JG, Shaw ES (1955) Financial aspects of economic development. Am Econ Rev 45(4):515–538

    Google Scholar 

  • Hadri K (2000) Testing for stationarity in heterogeneous panel data. Econ J 3(2):148–161

    Google Scholar 

  • Hakan Y (2011) Thresholds in the finance-growth Nexus: a cross-country analysis. World Bank Econ Rev 25(2):278–295

    Google Scholar 

  • Hall AR (2005) Generalized method of moments. Oxford University Press, Oxford

    Google Scholar 

  • Hamilton LC (1992) How robust is robust regression? Stata Tech Bull 1(2)

  • Hansen BE (1996) Inference when a nuisance parameter is not identified under the null hypothesis. Econometrica 64:413–430

    Google Scholar 

  • Hansen BE (1999) Threshold effects in non-dynamic panels: estimation, testing, and inference. J Econ 93:345–368

    Google Scholar 

  • Hansen BE (2000) Sample splitting and threshold estimation. Econometrica 68:575–603

    Google Scholar 

  • Hiebert LD (2002) The determinants of the cost efficiency of electric generating plants: a stochastic frontier production approach. South Econ J 68(4):935–946

    Google Scholar 

  • Hurlin C, Baptiste V (2008) Financial development and growth: a re-examination using a panel granger causality test, working papers halshs-00319995, HAL. https://ideas.repec.org/p/hal/wpaper/halshs-00319995.html

  • Islam N (1995) Growth empirics: a panel data approach. Q J Econ 110:1127–1170

    Google Scholar 

  • Kar M, Nazlioglu S, Agir H (2011) Financial development and economic growth nexus in the MENA countries: bootstrap panel granger causality analysis. Econ Model 28(1):685–693

    Google Scholar 

  • Khan MS, Senhadji AS (2003) Financial development and economic growth: a review and new evidence. J Afr Econ 12(2):89–110

    Google Scholar 

  • King RG, Levine R (1993) Finance and growth: Schumpeter might be right. Q J Econ 108(3):717–737

    Google Scholar 

  • Konya L (2006) Exports and growth: granger causality analysis on OECD countries with a panel data approach. Econ Model 23(6):978–992

    Google Scholar 

  • Kristensen IP, Wawro G (2003) Lagging the Dog? The robustness of panel corrected standard errors in the presence of serial correlation and observation specific effects. Paper presented at the 20th annual meeting of the Society for Political Methodology, University of Minnesota, Minneapolis

  • Law SH, Singh N (2014) Does too much finance harm economic growth? J Bank Financ 41:36–44

    Google Scholar 

  • Levin A, Lin C-F, Chu J, Chia-Shang (2002) Unit root tests in panel data: asymptotic and finite-sample properties. J Econ 108(1):1–24

    Google Scholar 

  • Levine R (2005) Finance and growth: theory and evidence. In P Aghion and S Durlauf (eds.), Handbook of Economic Growth 1(12):834–865

  • Levine R, Zervos S (1998) Stock markets, banks, and economic growth. Am Econ Rev 88(3):537–558

    Google Scholar 

  • Levine R, Loayza N, Beck T (2000) Financial intermediation and growth: causality and causes. J Monet Econ 46(1):31–77

    Google Scholar 

  • Liang Q, Teng JZ (2006) Financial development and economic growth: evidence from China. China Econ Rev 17(4):395–411

    Google Scholar 

  • Loayza NV, Rancie’re R (2006) Financial development, financial fragility, and growth. J Money Credit Bank 38(4):1051–1076

    Google Scholar 

  • Lucas RE Jr (1988) On the mechanics of economic development. J Monet Econ 22(1):3–42

    Google Scholar 

  • Luintel KB, Khan M (1999) A quantitative reassessment of the finance-growth nexus: evidence from a multivariate VAR. J Dev Econ 60(2):381–405

    Google Scholar 

  • Maddala G, Wu S (1999) A comparative study of unit root tests with panel data and a new simple test. Oxf Bull Econ Stat 61(S1):631–652

    Google Scholar 

  • Madsen J, Ang J (2016) Finance-led growth in the OECD since the nineteenth century: how does financial development transmit to growth? Rev Econ Stat 98(3):552–572

    Google Scholar 

  • McKinnon RI (1973) Money and capital in economic development. Brookings Institution Press, Washington

    Google Scholar 

  • Panizza U (2012) Finance and economic development. In ‘International Development Policy: Aid, Emerging Economies and Global Policies’ Part II, pp 141–160, Graduate Institute of International and Development Studies, Palgrave Macmillan UK

  • Patrick HT (1966) Financial development and economic growth in underdeveloped countries. Econ Dev Cult Chang 14:174–189

    Google Scholar 

  • Pesaran H (1997) The role of econometric theory in modeling the long run. Econ J 107(440):178–191

    Google Scholar 

  • Pesaran MH (2006) Estimation and inference in a large heterogeneous panel with a multifactor error structure. Econometrica 74(4):967–1012

    Google Scholar 

  • Pesaran MH (2007) Simple panel unit root test in the presence of cross-section dependence. J Appl Econ 22(2):265–312

    Google Scholar 

  • Pesaran H, Shin Y (1999) An autoregressive distributed lag modeling approach to cointegration in econometrics and economic theory in the 20th Century. In The Ragnar Frisch Centennial Symposium (pp. 371–413). Cambridge University Press

  • Pesaran H, Smith R (1995) Estimating long-run relationships from dynamic heterogeneous panels. J Econ 68(1):79–113

    Google Scholar 

  • Rajan RG (2005) Has financial development made the world riskier? Proceedings of the 2005 Jackson Hole Conference organized by the Kansas City Fed

  • Rajan RG, Zingales L (1998) Financial dependence and growth. Am Econ Rev 88(3):559–586

    Google Scholar 

  • Rioja F, Valev N (2004) Does one size fit all? A reexamination of the finance and growth relationship. J Dev Econ 74(2):429–447

    Google Scholar 

  • Robinson J (1952) The generalization of the general theory. In The rate of interest and other essays (pp. 67–142). London: Macmillan

  • Rodrik D (2008) Now's the time to sing the praises of financial innovation. Available at http://rodrik.typepad.com

  • Rodrik D, Subramanian A (2009) Why did financial globalization disappoint? IMF Staff Pap 56(1):112–138

    Google Scholar 

  • Romer PM (1986) Increasing returns and long-run growth. J Polit Econ 94(5):1002–1037

    Google Scholar 

  • Roodman D (2006) How to do xtabond2: an introduction to difference and system GMM in Stata. Center for Global Development Working Paper 103

  • Rousseau PL, Wachtel P (2002) Inflation thresholds and the finance-growth nexus. J Int Money Financ 21(6):777–793

    Google Scholar 

  • Rousseau PL, Wachtel P (2011) What is happening to the impact of financial deepening on economic growth? Econ Inq 49(1):276–288

    Google Scholar 

  • Saint-Paul G (1992) Technological choice, financial markets, and economic development. Eur Econ Rev 36:763–781

    Google Scholar 

  • Samargandi N, Fidrmuc J, Ghosh S (2015) Is the relationship between financial development and economic growth monotonic? Evidence from a sample of middle-income countries. World Dev 68:66–81

    Google Scholar 

  • Sassi S, Gasmi A (2014) The effect of enterprise and household credit on economic growth: new evidence from European Union countries. J Macroecon 39:226–231

    Google Scholar 

  • Schumpeter JA, Opie R (1934) The theory of economic development: an inquiry into profits, capital, credit, interest, and the business cycle. Harvard University Press, Cambridge

    Google Scholar 

  • Shaw ES (1973) Financial deepening in economic development. OUP, New York

    Google Scholar 

  • Shen CH, Lee CC (2006) Same financial development yet different economic growth–why? Journal of money. Credit Bank 38(7):1907–1944

    Google Scholar 

  • Soedarmono W, Hasan I, Arsyad N (2017) Nonlinearity in the finance-growth nexus: evidence from Indonesia. Int Econ 150:19–35. https://doi.org/10.1016/j.inteco.2016.11.003

    Article  Google Scholar 

  • Wolf M (2009) Why dealing with the huge debt overhang is so hard. Financial Times, 27 January

  • Zellner A (1962) An efficient method of estimating seemingly unrelated regressions and tests for aggregation bias. J Am Stat Assoc 57:348–368

    Google Scholar 

  • Zilibotti F (1994) Endogenous growth and intermediation in an archipelago economy. Econ J 104:462–473

    Google Scholar 

Download references

Author information

Authors and Affiliations

  1. IBS - Hyderabad, ICFAI Foundation for Higher Education (IFHE), A deemed to be University, Hyderabad, India

    Vighneswara Swamy &  Dharani M

Authors
  1. Vighneswara Swamy
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Dharani M
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Vighneswara Swamy.

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Swamy, V., Dharani M The tipping point of financial development? – evidence from OECD countries. Int Econ Econ Policy 17, 125–165 (2020). https://doi.org/10.1007/s10368-018-0420-z

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10368-018-0420-z

Keywords

JEL classification

Search

Navigation