Do banking sector and stock market development matter for economic growth?

Abstract

Financial development as a concept is multifaceted with no clear measurement or definition. Inference via individual proxies may result in an incomplete understanding of the relationship between financial development and economic growth, since sole proxies are unlikely to capture the true capacity of financial development. To address this issue, this paper utilizes a multiple indicators multiple causes (MIMIC) model to create a more complete measure of financial development. In doing this, we treat banking sector and stock market developments as two latent indicators of financial development and use the MIMIC model to predict them which are used as their proxies. Using data from 101 countries over the period 1990–2014, we use the predicted values of the two latent variables as regressors, among other controls, in the growth regression. We find a robust negative relationship between banking sector development and economic growth, whereas the effect of stock market development on economic growth is positive up to a threshold after which the effect becomes negative.

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Fig. 1
Fig. 2

Notes

  1. 1.

    Financial depth in general refers using private credit as a fraction of GDP as a measure; but the concept of financial development is much broader (see de la Torre et al. 2011 for details).

  2. 2.

    For details see Levine (2002).

  3. 3.

    Differently, Rose and Spiegel (2012) used the MIMIC model to examine the causes and consequences of 2008 financial crisis.

  4. 4.

    See Arellano and Bover (1995) and Blundell and Bond (1998) for details.

  5. 5.

    See Čihák et al. (2012) for details and various update of the same data set over the years.

  6. 6.

    For both banking sector and the stock market, we used different indicators to measure depth and efficiency. The results remain qualitatively similar to those reported in the paper.

  7. 7.

    For details on these indicators and classification, see Čihák et al. (2012).

  8. 8.

    The reasons for not including accessibility measure as accessibility are completely different from the other measures that have been used.

  9. 9.

    These income groups are defined in the World Bank database.

  10. 10.

    In our sample, around 31% of observations has stock market turnover higher than the overall average, whereas 50% of observations is above the median.

  11. 11.

    Results are not reported here to save space but are available from the authors upon request.

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Correspondence to Subal C. Kumbhakar.

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We would like to thank Bertrand Candelon, Editor-in-Chief and an anonymous referee for helpful comments.

Appendices

Appendix 1

See Figs. 3, 4.

Fig. 3
figure3

Relationship between banking sector and stock market deveopment predicted latent construct all countries (1990–2014)

Fig. 4
figure4

Relationship between banking sector and stock market deveopment predicted latent construct all countries (1990–2014)

Appendix 2

See Table 6.

Table 6 Subsample analysis for all countries

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Cave, J., Chaudhuri, K. & Kumbhakar, S.C. Do banking sector and stock market development matter for economic growth?. Empir Econ 59, 1513–1535 (2020). https://doi.org/10.1007/s00181-019-01692-7

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Keywords

  • Financial development
  • Economic growth
  • Multiple indicators multiple causes

JEL Classification

  • C22
  • G20
  • O40