Financial liberalization and channels of growth: a comparative study of developed and emerging economies

  • Archi BhatiaEmail author
  • Hans Raj Sharma


This paper investigates and compares the effect of financial liberalization on economic activity of developed and emerging economies, and explores the channels of capital accumulation and total factor productivity improvements through which economic activity can be enhanced. The theoretical and empirical literature has been marred with inconclusiveness because of, inter alia, clubbing different country groups together; addressing equity liberalization inadequately; leaving banking liberalization unaddressed; scantily covering the channels of economic activity; and measuring financial liberalization inadequately. Against this background, our sample consists of nine major developed and nine major emerging economies over a period of 1971–2013. We used panel data modeling technique and estimated a two-step GMM model to overcome the issue of endogeneity. We find financial liberalization to enhance economic activity in both set of countries; capital accumulation in the emerging economies; and TFP improvements in developed economies. Banking liberalization effect in emerging economies albeit is insignificant.


Financial liberalization Panel data Emerging economies Capital accumulation Total factor productivity 

JEL Classification

C23 C26 F15 F43 F62 


Compliance with ethical standards

Conflict of interest

On behalf of all the authors, the corresponding author states that there is no conflict of interests.


  1. Anderson, T. W. (1984). An introduction to multivariate statistical analysis. New York: Wiley.Google Scholar
  2. Arellano, M. (1987). Computing robust standard errors for within-groups estimators. Oxford Bulletin of Economics and Statistics, 49(4), 431–434.Google Scholar
  3. Arteta, C., Eichengreen, B., and Wyplosz, C. (2001). When does capital account liberalization help more than it hurts?, NBER Working Paper No. 8414.Google Scholar
  4. Atiken, B. J., & Harrison, A. E. (1999). Do domestic firms benefit from direct foreign investment? Evidence from Venezuela. The American Economic Review, 89(3), 605–618.Google Scholar
  5. Baltagi, B. H. (2001). Test of hypotheses with panel data. econometric analysis of panel data (2nd ed., pp. 53–75). England: Wiley.Google Scholar
  6. Bartolini, L., & Drazen, A. (1997). Capital-account liberalization as a signal. The American Economic Review, 87(1), 138–154.Google Scholar
  7. Basu, A., and Srinivasan, K. (2002). Foreign direct Investment in Africa—some case studies, IMF Working Paper WP/02/61.Google Scholar
  8. Bekaert, G., & Harvey, C. R. (2000). Foreign speculators and emerging equity markets. Journal of Finance, 55(2), 565–613.Google Scholar
  9. Bekaert, G., Harvey, C. R., & Lundbald, C. (2005). Does financial liberalization spur growth? Journal of Financial Economics, 77, 3–55.Google Scholar
  10. Bekaert, G., Harvey, C. R., & Lundbald, C. (2011). Financial openness and productivity. World Development, 39(1), 1–19.Google Scholar
  11. Bekaert, G., Harvey, C. R., & Lundblad, C. (2003). Equity market liberalization in emerging markets. The Federal Reserve Bank of St. Louis Review, 85(4), 53–74.Google Scholar
  12. Bencivenga, V. R., & Smith, B. D. (1991). Financial intermediation and endogenous growth. The Review of Economic Studies, 58(2), 195–209.Google Scholar
  13. Blundell, R., & Bond, S. (1998). Initial conditions and moment restrictions in dynamic panel data models. Journal of Econometrics, 87, 115–143.Google Scholar
  14. Bonfiglioli, A. (2008). Financial integration, productivity and capital accumulation. Journal of International Economics, 76(2), 337–355.Google Scholar
  15. Bonfiglioli, A., and Mendicino, C. (2004). Financial Liberalization, Bank Crisis and Growth: Assessing the Links, SSE/EFI Working Paper Series in Economics and Finance No. 567.Google Scholar
  16. Boot, A. (2000). Relationship banking: What do we know? Journal of Financial Intermediation, 9(1), 7–25.Google Scholar
  17. Borensztein, D. G., & Lee, J. W. (1998). How does foreign direct investment affect economic growth? Journal of International Economics, 45, 115–135.Google Scholar
  18. Brecher, R., & Calos, D. A. (1977). Tariffs, foreign capital and immiserizing growth. Journal of International Economics, 7, 317–322.Google Scholar
  19. Breusch, T. S., & Pagan, A. R. (1980). The lagrange multiplier test and its applications to the model specification in econometrics. The Review of Economic Studies, 47(1), 239–253.Google Scholar
  20. Bumann, S., Hermes, N., & Lensink, R. (2002). Financial liberalisation and economic growth: a meta-analysis. Technical report. London: EPPI-Centre.Google Scholar
  21. Chinn, M. D., & Ito, H. (2002). Capital account liberalization, institutions and financial development: Cross-country evidence. NBER Working Paper No. 8967.Google Scholar
  22. Chinn, M.D., & Ito, H. (2013). The Chinn-Ito Index, Retrieved from: Accessed 5 July 2015.
  23. Demirguc-Kunt,A., and Detragiache, E. (1998). Financial Liberalization and Financial Fragility, World Bank Policy Research, Paper No. 1917Google Scholar
  24. Diamond, D. W., & Dybving, P. H. (1983). Bank runs, deposit insurance, and liquidity. The Journal of Political Economy, 91(3), 401–419.Google Scholar
  25. Domer, E. D. (1946). Capital expansion, rate of growth, and employment. Econometrica, 14, 137–147.Google Scholar
  26. Edison, H. J., Levine, R., Ricci, L., & Slok, T. (2002). International financial integration and economic growth. Journal of International Money and Finance, 21, 749–776.Google Scholar
  27. Edwards, S. (2001). Capital mobility and economic performance: Are emerging economies different?, NBER Woking Paper, No. 8076.Google Scholar
  28. Gourinchas, P.O., and Jeanne, O. (2006). The elusive gains from international financial integration, IMF Working Paper WP/04/74.Google Scholar
  29. Grilli, V., & Milesi-Ferretti, G. M. (1995). Economic effects and structural determinants of capital control. IMF Staff Papers, 42(3), 517–551.Google Scholar
  30. Grossman, G.M., and Helpman.E. (1991). Trade, knowledge, spill-over, and growth, NBER Working Paper, No. 3485.Google Scholar
  31. Hansen, L. P. (1982). Large sample properties of generalized moments estimators. Econometrica, 50(4), 1029–1054.Google Scholar
  32. Hanushek, E.A., and Kimko, D.D.(2000). “Schooling, Labor-Force Quality and the Growth of Nations”, American Economic Review, Vol. 90, No.5, pp.1184-1208.Google Scholar
  33. Haskel, J. E., Pereira, S. C., & Slaughter, J. (2007). Does inward foreign direct investment boost the productivity of domestic firms? The Review of Economics and Statistics, 89(3), 482–496.Google Scholar
  34. Hausman, J. A. (1978). Specification tests in econometrics. Econometrica, 46(6), 1251–1271.Google Scholar
  35. Heckscher, E. (1919). The effects of foreign trade on the distribution of income. Ekonomisk Tidskrift, 21, 497–512.Google Scholar
  36. Hellmann, T. F., & Murdock, K. C. (1997). Financial sector development policy: The importance of reputational capital and governance. In R. Sabot & I. Skekely (Eds.), Development strategy and management of the market economy (2nd ed., pp. 269–323). Oxford: Clarendon.Google Scholar
  37. Hellmann, T. F., Murdock, K. C., & Stiglitz, J. E. (1996). Deposit mobilization through financial restraint. In N. Hermes & R. Lensink (Eds.), Financial development and economic growth: theory and experiences from developing economies (pp. 219–246). London: Routledge.Google Scholar
  38. Hellmann, T. F., Murdock, K. C., & Stiglitz, J. E. (2000). Liberalization, moral hazard in banking, and prudential regulation: are capital requirements enough? The American Economic Review, 90(1), 147–165.Google Scholar
  39. Henry, P. B. (2000). Stock market liberalization, economic reform and emerging market equity prices. The Journal of Finance, 55(2), 529–564.Google Scholar
  40. Henry, P. B. (2007). Capital account liberalization: Theory, evidence and speculation. Journal of Economic Literature, 45, 887–935.Google Scholar
  41. Heshmati, A., and Rashidghalam, M. (2016). Estimation of technical change and TFP growth based on observable technology shifters, IZA Institute of Labor Economics, Discussion Paper No. 10448.Google Scholar
  42. Hsiao, C. (2003). Simple regression with variable intercepts. In A. Chesher & M. O. Jackson (Eds.), Analysis of panel data (2nd ed., pp. 27–60). New York: Cambridge University Press.Google Scholar
  43. Isaksson, A. (2006). Total factor productivity, technological change and change in technical efficiency: A global picture. Vienna: Mimeo.Google Scholar
  44. Isaksson, A. (2007). Determinants of total factor productivity: A literature review, Research and Statistics Branch Staff Working Papers, United Nations Industrial Development Organization.Google Scholar
  45. Javorcik, B. S. (2004). Does foreign direct investment increase the productivity of domestic firms? In search of spill-over through backward linkages. The American Economic Review, 94(3), 605–627.Google Scholar
  46. Johnston, R. B., & Sundararajan, V. (Eds.). (1999). Sequencing financial sector reforms: country experiences and issues. IMF: Washington DC.Google Scholar
  47. Kaminsky, G.L., and Schmukler, S.L. (2003). Short-run pain, long-run gain: the effects of financial liberalization, IMF Working Paper, WP/03/34.Google Scholar
  48. Klein, M., and Olivei, G. (2005). Capital account liberalization, financial liberalization, financial depth and economic growth, NBER Working Paper Series, 7384.Google Scholar
  49. Kose, M.A., Prasad, E.S., and Terrones, M.E. (2007). How does globalization affect risk sharing? Patterns and channels, IMF Working Paper, WP/07/238.Google Scholar
  50. Kose, M.A., Prasad, E.S., and Terrones, M.E. (2008). Does openness to international financial flows raise productivity growth, NBER Working Paper, No. 14558.Google Scholar
  51. Kraay, A. (1998). In search of the macroeconomic effects of capital account liberalization. Washington: The World Bank.Google Scholar
  52. Krugman, P. (1979). Increasing returns, monopolistic competition, and international trade. Journal of International Economics, 9(4), 469–479.Google Scholar
  53. Krugman, P. (1993). Challenging conventional wisdom. Reprinted in: Krugman P (1996) Pop Internationalism. MIT Press, Cambridge Mass, pp. 129–154.Google Scholar
  54. Lane, P., & Milesi-Ferretti, G. M. (1999). The external wealth of nations: Measures of foreign assets and liabilities for industrial and developing nations. IMF Working Paper, WP/99/115.Google Scholar
  55. Lane, P., Milesi-Ferretti, G.M. (2006). The external wealth of nations Mark II, IMF Working Paper, WP/06/69.Google Scholar
  56. Levine, R. (2001). International financial liberalization and economic growth. Review of International Economics, 9(4), 688–702.Google Scholar
  57. Mckinnon, R. I. (1973). Money and capital in economic development. Washington: Brookings Institution.Google Scholar
  58. Mody, A., & Murshid, A. P. (2005). Growing up with capital flows. Journal of International Economics, 65(1), 249–266.Google Scholar
  59. Murphy, G., & Siedschlag, I. (2011). Human capital and growth of information and communication technology-intensive industries: Empirical evidence from open economies. Regional Studies, 47(9), 1–22.Google Scholar
  60. Newey, W. K., & West, K. D. (1987). A Simple positive semi-definite, heteroskedasticity and autocorrelation consistent covariance matrix. Econometrica, 55(3), 703–708.Google Scholar
  61. O’Donnell, B. (2001). Financial openness and economic performance, Trinity College, unpublished Ph.d Thesis.Google Scholar
  62. Obstfeld, E. (1994). The logic of currency crises, NBER Working Paper No. 4640, Feb.Google Scholar
  63. Ohlin, B. (1967). Theory of interregional and international trade. Cambridge, MA: Harvard University Press. (revised edition).Google Scholar
  64. Quinn, D. (1997). The correlates of change in international financial regulation. American Political Science Review, 91(3), 11–30.Google Scholar
  65. Quinn, D.P. (2000). Political and international financial liberalization, Paper presented at The Annual American Political Science Association Convention, Washington D.CGoogle Scholar
  66. Raza, M. W, & Mohsin, H. M. (2011). Financial liberalization and macroeconomic performance, empirical evidence from selected asian economies. Munich Personal Repec Archive Paper 34559, Oct.Google Scholar
  67. Ricardo, D. (1821). The principles of political economy and taxation, 3rd edn. London: John Murray.Google Scholar
  68. Rodrik, D. (1998). Who needs capital account convertibility?, Essays in international finance (Vol. 207). New Jersey: Princeton University.Google Scholar
  69. Samuelson, P. A. (1948). International trade and the equalization of factor prices. The Economic Journal, 58(230),163–184.Google Scholar
  70. Shaw, E. (1973). Financial deepening in economic development. New York: Oxford University Press.Google Scholar
  71. Smith, A. (1776). An inquiry into the nature and causes of the wealth of nations. An Electronic Classics Series Publication.Google Scholar
  72. Solow, R. W. (1956). A contribution to the theory of economic growth. The Quarterly Journal of Economics, 70(1), 65–94.Google Scholar
  73. Stiglitz, J. E. (2000). Capital market liberalization, economic growth and instability. World Development, 28(6), 1075–1086.Google Scholar
  74. Vlachos, J., and Waldenstrom, D. (2002). International financial liberalization and industry growth, SSE/EFI Working Paper Series in Economics and Finance, No. 513.Google Scholar
  75. White, H. (1984). Asymptotic theory for econometricians. Orlando, Florida: Academic Press, INC.Google Scholar
  76. Wooldrige, J. M. (2002). Basic linear unobserved effects of panel data models, and more topics in linear unobserved effects models. In Econometric analysis of cross-section and panel data (pp. 247–322). Cambridge, London: The MIT Press.Google Scholar
  77. Zhen, L. (2012). On the growth effects of equity market liberalization. Journal of Economic Development, 37(2), 59–77.Google Scholar

Copyright information

© Editorial Office, Indian Economic Review 2019

Authors and Affiliations

  1. 1.Department of Economics, Ramjas CollegeUniversity of DelhiDelhiIndia
  2. 2.Central University of Himachal PradeshDharamshalaIndia

Personalised recommendations