The spillover effects of financial development and institutions on economic growth in emerging economies: new insights from spatial Durbin approach

Ahmad, Mahyudin and Hall, Stephen G. and Law, Siong Hook and Nayan, Sabri (2023): The spillover effects of financial development and institutions on economic growth in emerging economies: new insights from spatial Durbin approach.

Abstract

Despite the extensive literature on the relationship between financial development (FD) and economic growth, previous studies have largely overlooked the potential spatial interdependence between countries. To address this gap, this paper employs spatial Durbin estimation that explicitly captures the spillover effects of FD and institutions on a panel dataset of 56 emerging countries over a 30-year period. The findings reveal a significant impact of FD on economic growth, although no evidence of its threshold effect. Institutions play a critical role in shaping the FD-growth relationship, with political institutions being the most influential in driving economic growth both within and across neighboring countries. On the other hand, improvement in economic institutions moderates the growth-effect of FD. Financial institutions drive the within-country effect of FD on growth, while the spillover effect primarily stems from financial markets in neighboring countries. The robustness of the findings is confirmed through a battery of tests. In conclusion, this empirical study offers valuable insights into the complex relationship between financial development, institutions, and economic growth in emerging countries. By considering spatial interdependencies and the role of institutions, policymakers can devise effective strategies to harness the positive effects of financial development and create an enabling environment for sustained and inclusive economic growth.

• Item Type: MPRA Paper
• Language: English
• Keywords: Economic growth, spillover effects, financial development, institutional quality, spatial Durbin model.
• Subjects: C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C31 - Cross-Sectional Models ; Spatial Models ; Treatment Effect Models ; Quantile Regressions ; Social Interaction Models; O - Economic Development, Innovation, Technological Change, and Growth > O1 - Economic Development > O16 - Financial Markets ; Saving and Capital Investment ; Corporate Finance and Governance; O - Economic Development, Innovation, Technological Change, and Growth > O4 - Economic Growth and Aggregate Productivity > O43 - Institutions and Growth

References

Abreu, M., de Groot, H. L. F., & Florax, R. J. G. M. (2005). Space and Growth: A Survey of Empirical Evidence and Methods. Region et Developement, 21, 12–43.

Acemoglu, D., Johnson, S., and Robinson, J. A. (2005). Institutions as a Fundamental Cause of Long-Run Growth. In P. Aghion and S. N. Durlauf (Eds.), Handbook of Economic Growth (Vol. 1A, pp. 386–471). Elsevier B.V. http://doi.org/10.1016/S1574-0684(05)01006-3

Adom, P.K., Amuakwa-Mensah, F. & Amuakwa-Mensah, S. (2020). Degree of financialization and energy efficiency in Sub-Saharan Africa: do institutions matter? Financial Innovation 6, 33 (2020).https://doi.org/10.1186/s40854-020-00192-3

Ahmad, M. (2019). Globalisation, Economic Growth, and Spillovers: A Spatial Analysis. Margin: The Journal of Applied Economic Research, 13(3), 255–276. https://doi.org/10.1177/2347631119841257

Ahmad, M., & Law, S. H. (2023). Financial development, institutions, and economic growth nexus: A spatial econometrics analysis using geographical and institutional proximities. International Journal of Finance & Economics, 1–23. https://doi.org/10.1002/ijfe.2791

Ahmad, M., & Hall, S. G. (2017). Economic growth and convergence: Do institutional proximity and spillovers matter? Journal of Policy Modeling, 39(6), 1065– 1085.

Ahmad, M., & Hall, S. G. (2022). The growth-effects of economic and political institutions: New evidence from spatial econometrics analysis using historical-based institutional matrix. Economic Change and Restructuring. https://doi.org/10.1007/s10644-022-09440-1

Al-Barakani, A., Bin, L., Zhang, X., Saeed, M., Qahtan, A. S. A., & Ghallab, H. M. H. (2022). Spatial analysis of financial development's effect on the ecological footprint of belt and road initiative countries: Mitigation options through renewable energy consumption and institutional quality. Journal of Cleaner Production, 366, 132696. https://doi.org/10.1016/j.jclepro.2022.132696

Anselin, L., and Bera, A. (1998). Spatial dependence in linear regression models with an introduction to spatial econometrics. In A. Ullah and D.E.A. Giles (Eds.), Handbook of Applied Economic Statistics. New York: Mercel Dekker.

Anselin, L., Bera, A., Florax, R., and Yoon, M. (1996). Simple diagnostic tests for spatial dependence. Regional Science and Urban Economics, 26(1), 77–104. Retrieved from http://www.sciencedirect.com/science/article/pii/0166046295021116

Anselin, L., Gallo, J. Le, and Jayet, H. (2008). Spatial Panel Econometrics. Advanced Studies in Theoretical and Applied Econometrics, 46, 625–660. http://doi.org/0.1007/978-3-540-75892-1_19

Arbia, G., Battisti, M., and Di Vaio, G. (2010). Institutions and geography: Empirical test of spatial growth models for European regions. Economic Modelling, 27(1), 12–21. http://doi.org/10.1016/j.econmod.2009.07.004

Arestis, P., Chortareas, G., and Magkonis, G. (2015). The financial development and growth nexus: A meta‐analysis. Journal of Economic Surveys, 29(3), 549-565.

Asongu, S.A. (2015). Finance and growth: new evidence from meta-analysis. Managerial Finance, 41(6), pp.615-639. Barro, R. J. (1991). Economic Growth in a Cross Section of Countries. The Quarterly Journal of Economics, 106(2), 407. http://doi.org/10.2307/2937943

Bijlsma, M., Kool, C. and Non, M. (2018): The effect of financial development on economic growth: a meta-analysis, Applied Economics. https://doi.org/10.1080/00036846.2018.1489503

Cecchetti, G., and Kharroubi, E. (2012). Reassessing the Impact of Finance on Growth. BIS Working Papers No. 381, Bank for International Settlements.

Cesi, C., Keefer, P., and Scartascini, C. (2021). The Database of Political Institutions 2020 (DPI2020), Washington, DC: Inter-American Development Bank Research Department. Retrieved from: https://publications.iadb.org/en/database-political-institutions-2020-dpi2020

Cournède, B., and Denk, O. (2015). Finance and economic growth in OECD and G20 countries. OECD Economics Department Working Papers, No. 1223, OECD Publishing, Paris.

Corrado, L., and Fingleton, B. (2012). Where is the Economics in Spatial Econometrics?. Journal of Regional Science, 52(2), 210–239. http://doi.org/10.1111/j.1467-9787.2011.00726.x

Crafts, N., and Venables, A. (2003). Globalization in history. A geographical perspective. In Globalization in historical perspective (pp. 323–370). University of Chicago Press. Retrieved from http://www.nber.org/chapters/c9592.pdf

Driscoll, J. C., & A. C. Kraay. 1998. Consistent covariance matrix estimation with spatially dependent panel data. Review of Economics and Statistics 80: 549-560.

Elhorst, J. P. (2003). Specification and Estimation of Spatial Panel Data Models. International Regional Science Review, 26(3), 244–268. http://doi.org/10.1177/0160017603253791

Elhorst, J. P. (2009). Spatial Panel Data Models. In M. M. Fischer and A. Getis (Eds.), Handbook of Applied Spatial Analysis (pp. 377–407). Springer. http://doi.org/10.1007/978-3-642-03647-7_19

Elhorst, J. P. (2010). Applied Spatial Econometrics: Raising the Bar. Spatial Economic Analysis, 5(1), 9–28. http://doi.org/10.1080/17421770903541772

Elhorst, P., Zandberg, E., & De Haan, J. (2013) The Impact of Interaction Effects among Neighbouring Countries on Financial Liberalization and Reform: A Dynamic Spatial Panel Data Approach, Spatial Economic Analysis, 8:3, 293-313, DOI: 10.1080/17421772.2012.760136

Feenstra, R. C., Inklaar, R. and Timmer, M. P. (2015). The Next Generation of the Penn World Table. American Economic Association. The American Economic Review. 105. 10. 3150--3182. Retreived from: http://www.ggdc.net/pwt

Havránek, T., Stanley, T. D., Doucouliagos, H., Bom, P., Geyer‐Klingeberg, J., Iwasaki, I., ... and Van Aert, R. C. M. (2020). Reporting guidelines for meta‐analysis in economics. Journal of Economic Surveys, 34(3), 469-475.

Henisz, W. J. (2017). The Political Constraint Index (POLCON) Dataset 2017 release. The Wharton School, University of Pennsylvania. Retrieved from https://mgmt.wharton.upenn.edu/profile/1327

International Monetary Fund, the (2019). Financial Development index, retrieved from https://data.imf.org/?sk=f8032e80-b36c-43b1-ac26-493c5b1cd33b

Khezri, M., Karimi, M. S., Khan, Y. A., & Abbas, S. Z. (2021). The spillover of financial development on CO2 emission: A spatial econometric analysis of Asia-Pacific countries. Renewable and Sustainable Energy Reviews, 145, 111110. https://doi.org/10.1016/j.rser.2021.111110

Law, S. H., and Singh, N. 2014. “Does too much finance harm growth?” Journal of Banking and Finance 41, 36-44.

Law, S. H., Azman-Saini, W. N. W., and Ibrahim, M. H. (2013). Institutional quality thresholds and the finance–growth nexus. Journal of Banking and Finance, 37(12), 5373-5381

Law, S. H., Kutan, A. M., and Naseem, N. A. M. (2018). The role of institutions in finance curse: Evidence from international data. Journal of Comparative Economics, 46(1), 174-191.

LeSage, J. P., & Pace, R. K. (2009). Introduction to spatial econometrics. Chapman and Hall/CRC Press.

Le Gallo, J., and Ertur, C. (2003). Exploratory spatial data analysis of the distribution of regional per capita GDP in Europe , 1980 – 1995. Papers in Regional Science, 201(2), 175–201. http://doi.org/10.1111/j.1467-8276.2006.00866.x

Manski, C. F. (1993) Identification of endogenous social effects: the reflection problem, Review of Economic Studies,60, 531-542.

Marshall, M. G., and Gurr, T. R. (2020). Polity V Project: Political Regime Characteristics and Transitions, 1800-2018. Center for Systemic Peace. Retrieved from: http://www.systemicpeace.org/inscrdata.html

North, D. C. (1990). Institutions, Institutional Change and Economic Performance. Cambridge: Cambridge University Press. http://doi.org/10.1017/CBO9780511808678

Pesaran, M. Hashem (2004) General Diagnostic Tests for Cross Section Dependence in Panels' IZA Discussion Paper No. 1240.

Pesaran, M. H. (2015). Testing Weak Cross-Sectional Dependence in Large Panels. Econometric Reviews 34(6-10): 1089-1117.

Pesaran, M. H. (2021). General diagnostic tests for cross-sectional dependence in panels. Empirical Economics 60: 13-50.

PRS Group, The. (2017). International Country Risk Guide dataset. Political Risk Services. Retrieved from https://datafinder.qog.gu.se/dataset/icrg

Qasemi, M. (2019). Meta-Analysis of the Empirical Relationship Between Financial Development and Economic Growth (Doctoral dissertation, 서울대학교 대학원).

Ran, M., Chen, L., & Li, W. (2020). Financial deepening, spatial spillover, and urban–rural income disparity: Evidence from China. Sustainability, 12(4), 1450. https://doi.org/10.3390/su12041450

Rey, S. J. & Janikas, M. V. (2005) Regional convergence, inequality, and space, Journal of Economic Geography, 5, 155–176

Samreen, I., & Majeed, M. T. (2020). Spatial econometric model of the spillover effects of financial development on carbon emissions: A global analysis. Pakistan Journal of Commerce and Social Sciences, 14(2), 569– 602.

Stakhovych, S. & Bijmolt, T. H. A. (2009) Specification of spatial models: a simulation study on weights matrices, Papers in Regional Science, 88, 389-408.

Stanley, T.D. (2001) Wheat from chaff: meta-analysis as quantitative literature review. Journal of Economic Perspectives 15(3): 131–150

Santos, G. Dos, and Faria, W. (2012). Spatial Panel data models and fuel demand in Brazil (No. 10-2012). TD Nereus. Retrieved from http://www.usp.br/nereus/wp-content/uploads/TD_Nereus_10_2012.pdf

Valickova, P., Havranek, T. and Horvath, R., 2015. Financial development and economic growth: A meta-analysis. Journal of Economic Surveys, 29(3), pp.506-526.

Vaona, A. (2009). Regional evidence on financial development, finance term structure and growth. In: Arbia, G., Baltagi, B.H. (eds) Spatial Econometrics. Studies in Empirical Economics. Physica-Verlag HD. https://doi.org/10.1007/978-3-7908-2070-6_10

Wang, C., Zhang, X., Ghadimi, P., Liu, Q., Lim, M. K., & Stanley, H. E. (2019). The impact of regional financial development on economic growth in Beijing–Tianjin–Hebei region: A spatial econometric analysis. Physica A: Statistical Mechanics and its Applications, 521, 635– 648. https://doi.org/10.1016/j.physa.2019.01.103

World Bank, The. (2020). World Development Indicators.

Zhong, J., & Li, T. (2020). Impact of financial development and its spatial spillover effect on green total factor productivity: Evidence from 30 Provinces in China. Mathematical Problems in Engineering, 2020, 1– 11. https://doi.org/10.1155/2020/5741387

Zhu, X., Chen, X., Cai, J., Balezentis, A., Hu, R., & Streimikiene, D. (2021). Rural financial development, spatial spillover, and poverty reduction: evidence from China. Economic Research-Ekonomska Istraživanja, 34(1), 3421– 3439. https://doi.org/10.1080/1331677X.2021.1875859