Financial Development, Institutional Quality and Poverty Reduction: Worldwide Evidence

Abstract

This paper tests the relationship between financial development, quality of institutions and poverty. To this end, we reviewed the literature and selected indicators of poverty, financial development and quality of institutions. Empirically, we used the three-stage least squares method to examine a sample of 132 countries observed over the 1980–2014 period. First, we proved that financial development does not improve the situation of the poor, while the effect of institution quality on poverty and financial development depends on the choice of indicators. Our robustness analysis pointed to the sensitivity of our results to the different financial development, quality of institutions and poverty indicators.

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

Notes

  1. 1.

    The Trickle Down’s theory of development is widely used in the 70th with the liberal politics of Ronal Reagan. This approach is recommended by The Chicago School guaranteeing that the wealth of the upper social classes would eventually benefit society as a whole. The main idea was to demonstrate that tax policies favoring the rich always end up favoring the poorest.

  2. 2.

    It should be noted that some authors preferred the use of the six indicators of Kauffman et al. (2009) from the Worldwide Governance Indicators, Heritage Foundation, International Country Risk Guide.

  3. 3.

    Readers interested in the subject may consult the following literature review: Hall and Lawson (2014). Economic Freedom of the World: An Accounting of the Literature.

References

  1. Abdin, J. (2016). Financial development and poverty reduction: Exploring the links between the issues using evidence from Bangladesh. International Journal of Financial Research, 7(4), 44–65.

    Article  Google Scholar 

  2. Abosedra, S., Muhammad Shahbaz, M., & Nawaz, K. (2016). Modeling causality between financial deepening and poverty reduction in Egypt. Social Indicators Research, 126(3), 955–969.

    Article  Google Scholar 

  3. Aggarwal, R., & Goodell, J. W. (2010). Financial markets versus institutions in European countries: Influence of culture and other national characteristics. International Business Review, 19(5), 502–520.

    Article  Google Scholar 

  4. Balach, R., & Law, S. H. (2015). Effects of financial development, institutional quality, and human capital on economic performance in SAARC countries. The Empirical Economics Letters, 14(2), 131–141.

    Google Scholar 

  5. Baltagi, B. H. (2011). Econometrics (5th ed.). Berlin: Springer.

    Google Scholar 

  6. Baltagi, B. H., Demetriades, P., & Law, S. H. (2009). Financial development and openness: Panel data evidence. Journal of Development Economics, 89(2), 285–296.

    Article  Google Scholar 

  7. Beck, T., Demirguc-Kunt, A., & Levine, R. (2007). Finance, inequality and the poor. Journal of Economic Growth, 12(1), 27–49.

    Article  Google Scholar 

  8. Boudriga, A., & Ghardallou, W. (2012). Democracy and financial development: Does the institutional quality matter. https://pdfs.semanticscholar.org/3193/129d17a4f170277b42323bc4f772a54207e3.pdf.

  9. Boyd, J. H., Levine, R., & Smith, B. (2001). The impact of inflation on financial sector performance. Journal of Monetary Economics, 47(2), 221–248.

    Article  Google Scholar 

  10. Cameron, A. C., & Trivedi, P. K. (2005). Microeconometrics: Methods and applications. New York, USA: Cambridge University Press.

    Google Scholar 

  11. Cepparulo, A., Cuestas, J. C., & Intartaglia, M. (2017). Financial development, institutions and poverty alleviation: An empirical analysis. Applied Economics, 49(36), 1–12.

    Article  Google Scholar 

  12. Charlton, A. (2008). Capital market liberalization and poverty. In J. A. Ocampo & J. Stiglitz (Eds.), The initiative for policy dialogue series (pp. 121–138). New York: Oxford Press.

    Google Scholar 

  13. Chemli, L. (2014). The nexus among financial development and poverty reduction: An application of ARDL approach from the MENA region. Journal of Economics and Development Studies, 2(4), 125–134.

    Article  Google Scholar 

  14. Cherif, M., & Gazdar, K. (2010). Macroeconomic and institutional determinants of stock market development in MENA Region: New results from a panel data analysis. International Journal of Banking and Finance, 7(01), 8.

    Google Scholar 

  15. Colombage, S. R. N. (2009). Financial markets and economic performances: Empirical evidence from five industrialized economies. Research in International Business and Finance, 23(3), 339–348.

    Article  Google Scholar 

  16. Compton, R. A., Giedeman, D. C., & Hoover, G. A. (2011). Panel evidence on economic freedom and growth in the United States. European Journal of Political Economy, 27(3), 423–435.

    Article  Google Scholar 

  17. Datt, G., & Ravallion, M. (2002). Why has economic growth been more pro-poor in some states of India than others? Journal of Development Economics, 68(2), 381–400.

    Article  Google Scholar 

  18. Deng, S., Elyasiani, E., & Mao, C. X. (2007). Diversification and the cost of debt of bank holding companies. Journal of Banking & Finance, 31(8), 2453–2473.

    Article  Google Scholar 

  19. Dhrifi, A. (2015). Financial development and the growth–inequality–poverty triangle: A comparative study between developed and developing countries. Journal of the Knowledge Economy, 6(4), 1163–1176.

    Article  Google Scholar 

  20. Effiong, E. (2016). Financial development, institutions and economic growth: Evidence from Sub-Saharan Africa. Working Paper/March 2016.

  21. Girma, S., & Shortland, A. (2008). The political economy of financial development. Oxford Economic Papers, 60(4), 567–596.

    Article  Google Scholar 

  22. Gwartney, J., Lawson, R., & Hall, J. (2015). Economic freedom of the world: 2015 annual report. Vancouver: Fraser Institute.

    Google Scholar 

  23. Habibullah, M. S., & Law, S. H. (2006). Financial development, institutional quality and economic performance in East Asian economies. Review of Applied Economics, 2(2), 201–216.

    Google Scholar 

  24. Hafer, R. W. (2013). Economic freedom and financial development: International evidence. Cato Journal, 33(1), 111–126.

    Google Scholar 

  25. Hair, J. F., Babin, B. J., Anderson, R. E., & Black, W. C. (2010). Multivariate data analysis: A global prospective (Vol. 7). Upper Saddle River, NJ: Pearson.

    Google Scholar 

  26. Hall, J. C., & Lawson, R. A. (2014). Economic freedom of the world: An accounting of the literature. Contemporary Economic Policy, 32(1), 1–19.

    Article  Google Scholar 

  27. Hasan, I., Wachtel, P., & Zhou, M. (2009). Institutional development, financial deepening and economic growth: Evidence from China. Journal of Banking & Finance, 33(1), 157–170.

    Article  Google Scholar 

  28. Ho, S. Y., & Njindan Iyke, B. (2017). Does financial development lead to poverty reduction in China? Time series evidence. Journal of Economics and Behavioral Studies, 9(1), 99–112.

    Article  Google Scholar 

  29. Huang, Y. (2010a). Political institutions and financial development: An empirical study. World Development, 38(12), 1667–1677.

    Article  Google Scholar 

  30. Huang, Y. (2010b). The determinants of financial development. New York: Palgrave Macmillan.

    Google Scholar 

  31. Huang, Y., & Sing, R. S. (2015). Financial deepening, property rights, and poverty: Evidence from Sub-Saharan Africa. Journal of Banking and Financial Economics, 1(3), 130–151.

    Article  Google Scholar 

  32. Huang, Y., & Temple, J. (2005). Does external trade promote financial development? Working Paper No. 05-575/July 2005.

  33. Huybens, E., & Smith, B. D. (1999). Inflation, financial markets and long-run real activity. Journal of Monetary Economics, 43(2), 283–315.

    Article  Google Scholar 

  34. Jaffee, D., & Levonian, M. (2001). Structure of banking systems in developed and transition economies. European Financial Management, 7(2), 161–181.

    Article  Google Scholar 

  35. Jeanneney, S. G., & Kpodar, K. (2008). Financial development and poverty reduction: Can there be a benefit without a cost? The Journal of Development Studies, 47(1), 143–163.

    Article  Google Scholar 

  36. Johansson, A. C., & Wang, X. (2012). Financial sector policies, poverty and inequality. Working Paper CERC-CCER Conference No. 24/September (2012).

  37. Kauffman D., Kraay, A., & Mastruzzi, M. (2009). Governance matters VIII: Aggregate and individual Governance indicators, 1996–2008. World Bank Policy Research Working Paper, No. 4978.

  38. Knack, S., & Keefer, P. (1995). Institutions and economic performance: Cross country tests using alternative institutional measures. Economics and Politics, 7(3), 207–227.

    Article  Google Scholar 

  39. Kpodar, K. R., & Jeanneney S. G. (2006). Développement financier, instabilité financière et croissance economique. Économie & Prévision, 147(3), 87–111.

    Article  Google Scholar 

  40. La Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. W. (1997). Legal determinants of external finance. The Journal of Finance, 52(3), 1131–1150.

    Article  Google Scholar 

  41. La Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. (1999). The quality of government. Journal of Law Economics and Organization, 15(1), 222–279.

    Article  Google Scholar 

  42. Law, S. H., Ibrahim, M. H., & Azman-Saini, W. N. W. (2012). Institutional quality thresholds and the finance—Growth nexus. Journal of Banking & Finance, 37(12), 5373–5381.

    Article  Google Scholar 

  43. Levine, R. (1998). The legal environment, banks, and long-run economic growth. Journal of Money, Credit and Banking, 30(3), 596–613.

    Article  Google Scholar 

  44. Mantecon, T. (2009). Mitigating risks in cross border acquisitions. Journal of Banking & Finance, 31, 640–651.

    Article  Google Scholar 

  45. Mauro, P. (1995). Corruption and growth. The Quarterly Journal of Economics, 110(3), 681–712.

    Article  Google Scholar 

  46. Minea, A., & Villieu, P. (2010). Financial development, institutional quality and maximizing-growth trade-off in government finance. Economic Modelling, 27(1), 324–335.

    Article  Google Scholar 

  47. Noreen, S., Gill, A. R., & Ali Khan, R. E. (2012). Financial development and poverty in Pakistan: Causality analysis. Archives Des Sciences, 65(11), 223–233.

    Google Scholar 

  48. North, D. C. (1990). Institutions, institutional change and economic performance. Cambridge: Cambridge University Press.

    Google Scholar 

  49. Odhiambo, N. M. (2009). Finance–growth–poverty nexus in South Africa: A dynamic causality linkage. The Journal of Socio-Economics, 38(2), 320–325.

    Article  Google Scholar 

  50. Perez-Moren, S. (2011). Financial development and poverty in developing countries: A causal analysis. Empirical Economics, 41(1), 57–80.

    Article  Google Scholar 

  51. Quartey, P. (2005). Financial sector development, savings mobilization and poverty reduction in Ghana. UNU-WIDER (2005). Working Paper No. 71/December 2005.

  52. Rachdi, H., & Mensi S. (2012). Does institutions quality matter for financial development and economic growth nexus? Another look at the evidence from MENA countries. In Economic Research Forum/September, WP-No. 705.

  53. Rajan, R., & Ramcharan, R. (2011). Land and credit: A study of the political economy of banking in the United States in the early 20th century. Journal of Finance, American Finance Association, 66(6), 1895–1931.

    Google Scholar 

  54. Rajan, R. G., & Zingales, L. (2003). The great reversals: The politics of financial development in the twentieth century. Journal of Financial Economics, 69(1), 5–50.

    Article  Google Scholar 

  55. Rashid, A., & Intartaglia, M. (2017). Financial development—Does it lessen poverty? Journal of Economic Studies, 44(1), 69–86.

    Article  Google Scholar 

  56. Sehrawat, M., & Giri, A. K. (2015). Financial development, poverty and rural–urban income inequality: Evidence from South Asian countries. Quality & Quantity, 50(2), 577–590.

    Article  Google Scholar 

  57. Seven, U., & Coskun, Y. (2016). Does financial development reduce income inequality and poverty? Evidence from emerging countries. Emerging Markets Review, 26, 34–63.

    Article  Google Scholar 

  58. Shahbaz, M. (2009). Financial performance and earnings of poor people: A case study of Pakistan. Journal of Yasar University, 4(16), 2557–2572.

    Google Scholar 

  59. Shahbaz, M., & Ur Rehman, I. (2013). Multivariate-based Granger causality between financial deepening and poverty: The case of Pakistan. Quality & Quantity, 48(6), 3221–3241.

    Google Scholar 

  60. Singh, R. J., & Huang, Y. (2015). Financial deepening, property rights, and poverty: Evidence from Sub-Saharan Africa. Journal of Banking and Financial Economics, 1(3), 130–151.

    Article  Google Scholar 

  61. Todaro, M. P. (2007). Economic development (6th edn.). NY: Addison Wesley Longman Ltd.

    Google Scholar 

  62. Uddin, G. S., Arouri, M., Teulon, F., & Shahbaz, M. (2014). Financial development and poverty reduction nexus: A cointegration and causality analysis in Bangladesh. Economic Modelling, 36(C), 405–412.

    Article  Google Scholar 

  63. Wang, Y., Cheng, L., Wang, H., & Li, L. (2015). Institutional quality, financial development and OFDI. Pacific Science Review, 16(2), 127–132.

    Article  Google Scholar 

  64. Yahyaoui, A., & Rahmani, A. (2009). Développement Financier et Croissance Economique: Rôle de la Qualité des Institutions. Panoeconomicus, 56(3), 327–357.

    Article  Google Scholar 

Download references

Author information

Affiliations

Authors

Corresponding author

Correspondence to Sami Mensi.

Appendix

Appendix

See Tables 9 and 10.

Table 9 Variable, definitions and their sources
Table 10 Sample.

Rights and permissions

Reprints and Permissions

About this article

Verify currency and authenticity via CrossMark

Cite this article

Kaidi, N., Mensi, S. & Ben Amor, M. Financial Development, Institutional Quality and Poverty Reduction: Worldwide Evidence. Soc Indic Res 141, 131–156 (2019). https://doi.org/10.1007/s11205-018-1836-0

Download citation

Keywords

  • Financial development
  • Quality of institutions
  • Poverty
  • 3SLS
  • Simultaneous equation modeling

JEL Classification

  • G20
  • I32
  • O17