Master Thesis
“Financial development and economic growth: cross
country evidence for selected ASEAN member countries”
Supervised by dr. A. Binnur Kibriscikli-Ozcandarli drs. H.C. Stek Compiled by Hita Supranjaya 1624814 Email: hitasupranjaya@hotmail.com
International Business & Management
Faculty of Management and Organization
Abstract
Using the OLS fixed effect, this study examines whether financial development would facilitate economic growth among the selected Association of South East Asian Nations (ASEAN) from 1990 until 2004. It focuses on the effects of two aspects of financial development on growth: banking sector development and stock market development. This study extends this framework to include the measure of capital flow in the growth model. Results suggest that among the two financial developments and capital flow, only the banking sector development shows positive relations to economic growth.
Table of Contents Abstract………1 Table contents………..2 Chapter 1………..3 1.1. Background………...3 1.2. Research question………...4 Chapter 2………..5 2.1. ASEAN history……….5
2.2. Studies of the relationship between financial development and economic growth………..6
2.3. Capital flow, financial development, and economic growth………...11
2.4. Trade liberalization………...12
2.5. Financial liberalization………....12
2.6. Joint role of trade and financial liberalization………...14
2.7. Conceptual model………...15 Chapter 3………18 3.1. Research formula………21 3.2. Research variables………..21 3.3. Explanation of variables……….22 Chapter 4………26 4.1. Descriptive………..26
4.2. Descriptive statistics result………...35
4.3. OLS fixed effect results………..35
Chapter 5………41
Chapter 6………43
References………..45
Chapter 1 Introduction
1.1. Background
Considerable attention has been drawn in recent years to the relationship between financial development and economic growth. Ever since the appearance of the influential research of Schumpeter (1911), Goldsmith (1969), Mckinnon (1973), Shaw (1973), and King and Levine (1993, 1997), a debate has been ongoing about the role of financial development in promoting long run growth.
The fast economic growth of the Asian countries has been a focus of interest for academicians and policy makers. The ASEAN as a geopolitical and economic organization consists of 10 countries. Among the member countries are Indonesia, Malaysia, Thailand, Philippines, Singapore, Vietnam, Myanmar, Laos, and Cambodia. Brunei Darussalam is not included in the study due to data unavailability and its distinctive economic characteristics. The ASEAN, a geo political and economic organization, as well as a trade facilitation group, has achieved a high level of financial development due to the substantial trade integration in 1992. For the past decade, many literatures have examined the empirical relationship between financial development and economic growth (Schumpeter, 1911; King and Levine, 1993). Most of the research up until now has concentrated on the trade enhancing effect, flow of Foreign Direct Investment (FDI), domestic assets of central and commercial banks, and flow of domestic credit toward economic growth. Moreover, there has been an increase of interest in exploring the connection between financial development and economic growth. Since most recent studies highlight the impact of financial development on economic growth, this paper aims to study whether financial development would facilitate economic growth among the ASEAN member countries. While a number of studies have been conducted in this area, similar empirical studies on ASEAN countries have never been done. This study attempts to fill in the literature gap by exploring the finance growth relationship among ASEAN countries.
two major aspects of financial development that can enhance growth: stock market and banking sector development. This study extends this framework to include the measure of capital flow in the growth model. Evidence from earlier studies (Edison et al., 2002 and Levine, 2001) indicates that capital flow may boost economic growth through increasing stock market and banking sector activities. To be more specific it explores whether financial development in these three sectors facilitated economic growth among the member countries. The diverse country sample among the ASEAN countries may resulted in different growth enhancing effect in the countries’ level of economic development.
1.2. Research Question
“What are the effects of financial development on economic growth in the ASEAN member countries?”
Chapter 2
Related empirical literature
2.1. ASEAN history
ASEAN was heralded by an organization called the Association of Southeast Asia (ASA), an alliance consisting of the Thailand, Philippines, and Malaysia which was formed in 1961. Six years later on August 8 1967, the alliance itself was actually established when the five foreign ministers of Indonesia (Appendix A), Malaysia (Appendix B), Thailand (Appendix C), Philippines (Appendix D), and Singapore (Appendix E) met at the Thai Department of Foreign Affairs building in Bangkok and signed the ASEAN Declaration, more commonly known as the Bangkok Declaration. During the Bangkok Declaration, Adam Malik of Indonesia, Narciso R. Ramos of the Philipines, Tun Abdul Razak of Malaysia, S. Rajaratnam of Singapore, and Thanat Khoman of Thailand are considered to be the organization’s founding fathers.
On July 28, 1995, Vietnam (Appendix F) became the seventh member, Myanmar (Appendix G) and Laos (Appendix H) joined two years later in July 23, 1997. On April 30 1999 following the stabilization of its government Cambodia (Appendix I) joined the ASEAN alliance. This allowed the alliance to include all countries within Southeast Asia. At the turn of the 21st century, issues shifted to involve a more environmental prospective. The organization started to discuss environmental agreements. These included the signing of the ASEAN Agreement on Transboundary Haze Pollution in 2002 as an attempt to control haze pollution in Southeast Asia. Unfortunately, this was unsuccessful due to the outbreak of the 2005 Malaysian haze and the 2006 Southeast Asian haze. Other environmental treaties introduced by the organization include the Cebu Declaration on East Asian Energy Security and the Asia Pacific Partnership on Clean Development and Climate, both of which are responses to Global Warming and the negative effects of fossil fuel. Through the Bali Concord 11 in 2003, ASEAN has subscribed to the notion of democratic peace, which means all member countries believe democratic processes will promote regional peace and stability. Also the non-democratic members all agreed that it was something all members should aspire to.
The urge to further integrate the region was promoted by Mahatir Mohammad of Malaysia. Beginning in 1997, the alliance began creating organizations within its framework with the intention of achieving certain goals. The goals achieved comprised of ASEAN Plus Three created to strengthen diplomatic ties and network with the People’s Republic of China, Japan, and South Korea and East Asia Summit (India, Australia, and New Zealand). This new grouping acted as a prerequisite for the planned East Asia Community, which was supposedly patterned after the own defunct European Community. In December 12 2005 the ASEAN Eminent Persons Group (EPG) was created to study the possible successes and failures of this policy as well as the possibility of establishing an ASEAN Charter. In 2006, ASEAN was given observer status at the United Nations General Assembly.
economic growth. Pagano (1993) and Levine (1997) contend financial development can influence the rate of economic growth by altering the productivity growth and the efficiency of capital. Moreover, financial development can influence the accumulation of capital through its impact on the savings rate or by altering the proportion of savings.
measures of financial development are based on the degree of monetization and bank development.
In addition, Rousseau and Sylla (2003) also employ a cross country regression framework to make the case for finance led growth. They use a long data set (1850-1997) for the US, the UK, Japan, France, Germany, and the Netherlands. Their study was the first to apply recent cross-country regression techniques in a systematic study of the finance-growth nexus that includes the period before 1960. They use the first observations of each decade as regressors to ameliorate the impact of possible reverse causality from growth to additional finance. This technique has flaws in which it cannot fully eliminate the simultaneity problem due to autocorrelation in the time series for financial depth, but it does ensure that all regressors are predetermined and thus plausible determinants of subsequent growth. They uncovered a robust correlation between financial factors and economic growth that is consistent with a leading role for finance, and show that these effects were the strongest over the 80 years preceding the Great Depression. They also showed that countries with a more sophisticated financial system engage in trade prove to be better integrated with other economies by econometrically identifying roles for both finance and trade in the absolute convergence of long term interest rates that occurred among the Atlantic economies between 1850 and the start of the First World War.
intervention in the financial system has a negative effect on the growth rate. Demirguc-Kunt and Levine (1996b) used 44 countries data from 1986 through 1993 had found that a positive relationship between stock market and financial institutions development. Demetriades and Hussein (1996) employed time series data for each of 16 countries showed that finance is a leading sector in the process of economic development. Also, Odedokun (1996) employed time series data for 71 developing countries and showed that financial intermediation had promoted economic growth, in some 85% of the countries.
According to Aziz and Duenwald (2002) financial development can affect growth through three main channels. First, it can increase the marginal productivity of capital by collecting information to evaluate alternative investment projects and by risk sharing. Second, it can raise the proportion of savings channeled to investment via financial development (by reducing the resources absorbed by financial intermediaries and thus increasing the efficiency of financial intermediation). Third, it can raise the private savings rate. In addition, Ansari (2002) noted that financial development contribute to economic growth in the following ways: (a) financial markets enable small savers to pool funds, (b) savers have a wider range of instruments stimulating savings, (c) efficient allocation of capital is achieved as the proportion of financial saving in total wealth rises, (d) more wealth is created as financial intermediaries redirect savings from the individuals and the slow-growing sectors to the fast-growing sectors, (e) financial intermediaries partially overcome the problem of adverse selection in the credit market, and (f) financial market encourages specialization in production development of entrepreneurship and adoption of new technology.
to their funds while simultaneously offering borrowers a long term supply of capital. At the aggregate level, liquidity risk that individual investors face is perfectly diversified (Greenwood and Smith, 1997). Second, financial intermediaries improve the allocation of funds over investment projects by acquiring ex-ante information. Information asymmetries generate a need for prospective research: firms with productive investment projects but no funding have an informational advantage about the quality of their investment. It is difficult and costly for individual investors to screen projects and their managers. Third, ex-post monitoring of management and exertion of corporate control also induces the need for financial intermediaries. The monitor needs not to be monitored when his asset holdings are perfectly diversified. Therefore stock markets promote better corporate control. Fourth, financial markets mobilize savings in an efficient way. Stock markets establish a market place where investors feel comfortable to relinquish control of their savings. Fifth, financial markets increase specialization. Increased specialization requires lower transaction costs. Yet there has been no other financial function since then.
In shedding the light of vast development in stock markets, more recent studies widened the analysis to examine the linkage between stock market development and economic growth. Furthermore, Levine and Zervos (1998) first incorporated stock market development in addition to banking sector development as another potential foundation of economic growth. The outcomes are consistent with the idea that a well developed stock market and banking sector would promote higher growth. In particular, both measures of financial development (stock market liquidity and bank credit) are positively correlated with the current and future rates of economic growth.
the studies also emphasize the inclining importance of stock market development in accelerating growth.
Recent research by Beck, Demirguc-Kunt and Maksimovic (2004) examines the micro level of the impact of financial constraints due to the lack of financial development on firm growth. They find that the impact of financial underdevelopment is more financially constraining on small rather than large firms. Furthermore, Almeida et al. (2004) contend that small firms are also more likely to be financially constrained in more general settings. They also note that the argument for size as a good observable measure of financial constraints is that small firms are typically young, not well known and therefore more vulnerable to capital market imperfections. Love (2003) provides evidence that financing constraints decrease with financial market development. Prior researches have mostly explored the determinants of the level of cash holdings in an international setting. For instance, Dittmar, Smith and Servaes (2003) showed that cash holdings are higher in countries with weak investor protection rights. They interpret this result as consistent with the agency cost explanation that investors in countries with poor investor protection cannot force managers to spew unnecessary cash equilibrium. In addition, Pinkowitz, Stulz, and Williamson (2003) point out that Smith and Servaes’ findings are consistent with the manager’s action on behalf of shareholders interest.
2.3. Capital flow, financial development, and economic growth
opening up of the banking sector to foreign investors creates a more competitive atmosphere in the banking sector (Tang, 2006). This would spur more improvement in domestic banking efficiency, thereby boosting economic growth.
2.4. Trade liberalization
Similarly, removal of trade restrictions help to stabilize the development process by improving efficiency and return economies from distorted factor prices to production frontiers. Moreover, trade openness will improve domestic technology, production process will be more efficient, and hence productivity will rise (Jin, 2000). Trade liberalization and growth relations may occur through investment, and trade openness may provide greater access to investment goods (Levine and Renelt, 1992). Countries that liberalize their external sector and reduce impediments to international trade can experience relatively higher economic growth. It is generally agreed that an open trade regime is crucial for economic growth and development (Sukar and Ramakrishna, 2002).
2.5. Financial liberalization
The effect of capital account openness on economic growth is the issue that is still debated. According to Grill and Milesi-Ferretti (1995), Rodrik (1998), and Edison et al. (2002a), no correlation exists between capital account liberalization and growth prospects. On the contrary, Quinn (1997) and Toyoda (2003) find a positive relation between capital account liberalization and growth. Taking stance at an ambiguous ground, Edison et al. (2002b) and Chandra (2003) find that the effect is mixed or fragile. A rare result on the study is provided by Klein (2003) who finds an inverted U-shaped effect: Capital account liberalization has no impact on the poorest and the richest countries but a substantial impact on the middle-income countries.
Levine (2001) confirms that international financial liberalization can improve the functioning of domestic financial markets and banks and accelerate economic growth. He concludes three summaries. First, liberalizing restrictions on international portfolio flows tends to enhance stock market liquidity. In turn, enhanced stock market liquidity accelerates economic growth primarily by boosting productivity growth. Second, allowing greater foreign bank presence tends to enhance the efficiency of the domestic banking system. In turn, better- developed banks spur economic growth primarily by accelerating productivity growth. Thus, international financial integration can promote economic development by encouraging improvements in the domestic financial system.
The finance growth linkage may largely depend on the levels of economic development and financial liberalization. First, there has been intense debate whether the level of growth effects may vary with the level of economic development. Levine (1997) argues that developed countries with better financial infrastructures tend to experience higher economic growth than developing countries. As countries become richer, the sizes of their stock market and banking sector would grow through inducing more capital accumulation and technological innovation. Moreover, better financial infrastructures would usually induce more investment in higher return projects, possibly leading to high economic growth. This argument is further supported by Deidda and Fattouh (2002). They note that the degree of growth effect would increase directly with the level of economic development. Second, another major factor that can affect the finance growth relationship is the degree of financial liberalization in the stock market and the banking sector. Evidence obtained by Kassimatis and Spyrou (2001) indicated that financial development would further boost economic growth in countries with a more liberalized financial market, especially those with a high level of stock market liberalization. In contrast, countries with highly regulated financial markets controlled by the government would derive lower and even shorter term growth effects of stock market development. The fact that these stock markets may be poorly managed, the stock market development can actually hinder rather than promote economic growth.
2.6. Joint role of trade and financial liberalization
Therefore the above explanations will lead to the three hypotheses as follows.
Hypothesis 1:
There is a positive relationship between the development of banking sector and economic growth in selected ASEAN countries
Hypothesis 2:
There is a positive relationship between the development of stock market and economic growth in selected ASEAN countries
Hypothesis 3:
There is a positive relationship between capital flow and economic growth in selected ASEAN countries
2.7. Conceptual model
Chapter 3 Methodology
In this research the researcher collected quantitative data to conduct statistical tests. The major objective of this research is to analyze whether financial development would promote economic growth among the ASEAN countries in the period of 1990-2004. The conventional model comprises the standard set of variables that measures the effects of two aspects of financial development: the stock market and the banking sector. This study extends this framework to include the measure of capital flow in the growth model.
research will only adopt the proxies for the banking sector development such as their LLY, PRIVY, PRIVATE, and BANK. However in this research, the variable LLY and BANK will be called LIQLIAB and COMMBANK to make it simpler.
related with the number of domestic companies. Tang (2006) contends that a high value of COMPANY indicate a country tends to have a well developed stock market. CAPINFL is used to measure the international financial openness of a country. The data will be regressed using the panel data approach with fixed effects.
This statistical approach conducted in this research is similar to what King and Levine (2001) and Levine and Zervos (1998) did. King and Levine (2001) first attempted correlation statistic on the four financial indicators, growth, and the sources of growth. The sources of growth discussed in their research are GDP per capita, physical capital accumulation rate (GK), ratio of domestic investment to GDP (INV), and a residual measure of improvements in the efficiency of physical capital allocation (EFF). Then, they use cross country regressions (panel data fixed effects) to gauge the strength of the partial correlation between financial development and the growth indicators. Similarly, Levine and Zervos (1998) conducted correlation on the six stock market indicators, the traditional financial depth variable to measure the banking sector development, and the growth variables. The financial depth variable in their research consists of only the ratio of commercial bank assets divided by commercial bank assets divided by GDP and termed this variable BANK CREDIT. Whereas the growth variables consist of long run per capita GDP growth (OUTPUT GROWTH), rate of real per capita physical capital stock growth (CAPITAL STOCK GROWTH), everything else (PRODUCTIVITY GROWTH), and gross private savings (SAVINGS). Their subsequent approach is conducting cross country regressions to conduct the strength of the partial correlation between each of the fourth growth indicators and measures of banking and stock market development.
are the most significant to economic growth. The difference between King and Levine (2001) and Levine and Zervos (1998) and this research is that this research will extend the framework to include capital flow as a determinant of economic growth. The data to be analyzed derived from the International Monetary Fund (IMF), International Financial Statistics (IFS), World Development Indicators (WDI) and the World Bank. The time frame used in this research is from the year 1990 until 2004.
3.1. Research formula
The set of regression uses Tang (2006) growth model. The set of explanatory variables in the growth equation contain liquid liabilities, claims on non financial private sector to GDP, claims on non financial private sector to domestic credit, commercial bank assets to commercial bank assets plus central bank assets to measure the banking sector development and the size of the domestic stock market to GDP, the stocks being traded to GDP, the stocks being traded to total value of stocks, companies listed in stock market to measure the stock market development. Moreover, this research incorporates capital inflow to measure the capital flow.
The modified growth model in this study is given as follows
Log GROWTH = B0 log(LIQLIAB)+ B1 log(PRIVY) + B2 log(PRIVATE) + B3
log(COMMBANK) + B4 log(MKTCAP) + B5 log(VALTRADE) + B6 log(TURNOVER) +
BB7 log (COMPANY) + B8 log(CAPINFL)
3.2. Research variables Dependent variables
GROWTH= growth rate of per capita GDP
Independent variables
1. Banking sector development
PRIVY= ratio of claims on non financial private sector to GDP
PRIVATE= ratio of claims on non financial private sector to domestic credit
COMMBANK (Commercial bank) = commercial bank assets divided by the total of commercial and central bank’s assets
2. Stock market development
MKTCAP (Market capitalization) = total value of stocks listed on the domestic market divided by GDP
VALTRADE= total of value of stocks being traded divided by GDP
TURNOVER= total value of stocks being traded divided by the total value of stocks listed on the domestic market
COMPANY= number of domestic companies listed on the stock exchange market
3. Capital flow
CAPINFL (Capital Inflow) = the amount of foreign direct investment and portfolio inflows divided by GDP
3.3. Explanation of variables GDP
The dependent variable is the growth rate of per capita GDP annually.
LIQLIAB
shortcomings. It may not accurately measure the effectiveness of the financial sector in improving informational asymmetries and easing transaction costs. Moreover, liquid liabilities include deposits by one financial intermediary in another, which may involve double counting. This research assumes that the size of the financial intermediary is positively correlated with the provision and quality of financial services and many researchers use this measure of financial depth (Goldsmith, 1969; King and Levine, 1993; and McKinnon, 1973). Therefore, the researcher includes it as one of the proxies of banking sector development.
PRIVY
This is the most typical measure for banking sector development. This indicator is the ratio of the total credits given by commercial banks to the private sector and divided by GDP. PRIVY is considered to be another important variable as it only measures the total credits issued to the private sector, as opposed to the credits issued to governments and other public enterprises (Levine and Zervos, 1998). In addition, referring to Levine et al. (2000), bank credit reflects the high availability of financial services and suggests a well-functioning banking system.
PRIVATE
A financial system that funnels credit to the government or state owned enterprises may not be evaluating managers, selecting investment projects, pooling risk, and providing financial services to the same degree as financial systems that allocate credit to the private sector. Therefore this study includes the proportion of credit allocated to private enterprises by the financial system within the total amount of credits.
COMMBANK
corporate control, mobilizing savings, easing transactions, and providing risk management facilities to client. In contrast to liquid liabilities, COMMBANK does not reflect the quality and quantity of financial services available at the financial intermediaries. The intuition underlying this proxy, COMMBANK measures the abilities of the commercial bank to identify profitable investment, facilitate risk management and subsequently mobilize savings in comparison to those of the central banks (Tang, 2006). Thus, King and Levine (1993) recommend including COMMBANK as an additional measure of banking sector development.
MKTCAP
MKTCAP is the common indicator for the size of capital market which equals the total value of stocks listed on the domestic market divided by GDP. A larger value of MKTCAP indicates a large country with a larger stock market. In this regard, a country with a well developed stock market tends to have a larger stock market relative to the size of its economy.
VALTRADE
VALTRADE is the total value of stock being traded divided by GDP. Since VALTRADE measures the volume of stock being traded as a share of total economic output, it should accurately reflect the stock market liquidity relative to the size of the economy (Levine and Zervos, 1998).
TURNOVER
COMPANY
COMPANY is the most simple and direct indicator for stock market development. This particular variable measures the total number of domestic companies listed on the stock exchange market. The number of domestic companies is strongly associated with the overall efficiency of the stock market operation. A high value of COMPANY suggests that a country tends to have a well developed stock market.
CAPINFL
Chapter 4
Results and discussions
4.1. Descriptive
Economic performance variable GDP per capita
country is saddled with a large public debt and limited financial resources. Moreover, the presence of US facilities in the country and the political instability worsens the GDP growth.
During the Asian financial crisis, Indonesia was hit the hardest with -14.8 percent growths if compared to other neighboring countries. According to Radelet and Sachs (1998), the financial crisis is due to the domestic policy failures and inherent stability of the open economy model. Moreover the trigger of the crisis lies in the vulnerability of the open economic system to financial panic. A sudden withdrawal of funds by foreign investors also precipitates economic crisis. Thailand as the trigger of the Asian financial crisis comes second after Indonesia with -11.4 percent growths. In addition, Malaysia, Singapore, and Philippine suffered -9.61, -4.11, and -2 percent growth. On the other side Vietnam, Myanmar, Laos, and Cambodia were affected the least valuing at 4.2, 4.4, 1.5, and 10.4 percent growth. These posts communist countries were least affected by the financial crisis because their economic characteristics were not as complicated as to other ASEAN member countries and rely largely on subsistence agriculture, and tourism. While the countries that were affected by the financial crisis the most consist of complicated economic characteristics and liberalized trade and finance. As the result of the financial crisis, all of the countries suffered from inflation, recession, increased price of raw materials and resources although the effects vary from one another.
the highest growth averaging 1.94 percent. The growth was resulted by the strong macroeconomic fundamentals and the government’s effort to cut business costs that rebounded in 1999 and 2000. However from 2001 until 2003, not only Singapore but also Thailand, Philippine, and Malaysia’s economy was hit hard by the global recessions as well as the slump in the technology sector and recurring outbreaks of the bird flu which caused a substantial reduced in the tourism sector and consumer spending.
Banking sector development variables Liquid liabilities
Figure 2 provides the line chart for liquid liabilities of the ASEAN member countries. Since 1990 until 1997, the size of the financial intermediary sector of the ASEAN member countries has been growing steadily. Singapore as the most developed countries with an average of 118 percent surpasses the other members. This indicates that Singapore has the highest and largest financial services in terms of quality and quantity compared to others. As expected, Malaysia ranks second after Singapore with an average of 102 percent. On the contrary, Cambodia’s financial intermediary sector has the lowest quality and the smallest quantity with an average of 4.9 percent.
In the 1998 Asian financial crisis, Singapore and Myanmar are the only countries that experienced setbacks in the size of its financial intermediary sector whereas others experience growth despite the Asian financial crisis occurrence. The subsequent effect of the Asian financial crisis started in 1999 whereas all of the ASEAN member countries endured fluctuations in growth and Cambodia is still at the bottom of the chart averaging 15 percent. Although Indonesia’s financial intermediary sector size is not the smallest but it is the least developing since 1999 from 58 percent stumbling down incrementally to 45 percent.
Privy
Singapore has the highest average valuing 90 percent. Moreover, the amount of credits channeled to the private sector from the overall GDP has not been quite developing for the remainder of the ASEAN member countries. For instance, Indonesia indicates volatility in the amount of credits channeled to the private sector from the overall GDP averaging 1 percent. Whereas Vietnam and Myanmar are averaging 4 percent and Thailand has an average of 3 percent. As for Malaysia, Laos, and Cambodia have an average of slightly above 0 percent. However, the analysis for Malaysia, Laos, and Cambodia cannot be considered as accurate due to incomplete data throughout the years.
In 1998, Indonesia, Thailand, Singapore, Vietnam, and Myanmar show an increase in the amount of credits funneled to the private sector from the overall GDP. While the value in other ASEAN member countries decreased slightly. After the Asian financial crisis in 1998, the amounts of credits funneled to the private sector from the overall GDP indicate a volatile trend for most of the member countries. Frankly speaking Indonesia indicates a downward turn with an average of 0.7 percent.
Private
downward trend in their banking functions performance. On the contrary, Thailand, Philippines, and Singapore indicate an upward trend of their banking performance with Singapore averaging 130 percent.
Commercial bank
Throughout 1990 until 1997, the amount of saving allocated for investments by the commercial and central banks of the ASEAN member countries endured fluctuations as can be seen in Figure 5. Some countries such as Indonesia, Malaysia, Philippines, and Cambodia show a downward trend, while others do not. Despite the downward trend, Philippines has the highest value of savings allocated for investment even though the country is saddled with large public debt and limited financial resources. Many of the country’s expenditure went into the investment of infrastructure, education, and healthcare. Unlike Philippines, Indonesia’s investment savings allocation declined incrementally averaging 28 percent even though the 1990 initial banking sector reform which allows for new entrants and reduced foreign exchange transactions was imposed. It is due to the fact that the Indonesia’s banking system shows signs of incapability of performing its intermediation function. In addition, Cambodia as the poorest country among the ASEAN member also faces a downward trend in the savings allocation for investment averaging 34 percent due to the government inefficiency in revenue and basic infrastructure allocation. Nevertheless, the re-establishment of private sector banks in the early 1990s made far reaching changes in the banking sector. Singapore categorized as the most developed country among the ASEAN member countries shows a low average of its savings allocated for investments with an average of only 0.09 percent, due to the fact that Singapore is a heavy provider of loans outside the country.
Stock market development variables
The stock market development variables only refers to the five main ASEAN member countries which consists of Indonesia, Malaysia, Thailand, Philippines, and Singapore. Besides to the well established stock market in each of those countries, data are either unavailable or incomplete for the remainder countries even though Vietnam currently established a stock market since 2002.
Market capitalization
Throughout 1990 until 1997 the size of the stock market to GDP per capita of each country experienced high growth (particularly in Malaysia) in the first three years as depicted in Figure 6. However the level of growth of each country varies from one another depending on the economic characteristics of the country before each of the countries experienced volatility until 1997. As can be seen from the figure, Indonesia stock market size proved to be the lowest with an average of 19 percent if compared to its closest neighbor country Malaysia with an average of 204 percent. Meanwhile for Thailand, Philippines, and Singapore indicate an average growth of 55, 56, and 146 percent. During 1993, Philippines market capitalization increased by two fold as the result of the merger into one single unit of 2 stock market exchanges in Manila and Makati.
Value trade
Starting in the year 1990 until 2004, the contribution of the total value of stock traded in the domestic market indicates a steady growth rate among the five main ASEAN member countries with a variety of average growth. Referring to figure 7, Indonesia has the lowest average of 7 percent after the Philippines stock market with an average of 15 percent. Malaysia has the most developed stock market with an average of the total stock being traded of 111 percent and followed by Singapore and Thailand with an average of 70 and 40 percent.
During the Asian financial crisis, Indonesia is the only one that experienced growth in the total value of stock being traded to GDP per capita. Unlike market capitalization, the total value of stock being traded to GDP per capita experienced a slow growth with a slight downturn in 2001. From 1999 until 2004, Singapore’s stock market development demonstrate the most prominent growth compared to other 4 ASEAN member countries with an average growth in the total value of stock being traded of 66 percent. This is mainly due to the boost of the total value of stock being traded in the domestic market as a result of the merger of Stock Exchange of Singapore and SIMEX in 1999.
Turnover
From 1990 until 1997, the volume of stock being traded relative to the size of the economy shows a fluctuate trend among the five main ASEAN member countries. Referring to figure 8, Thailand has the highest turnover with an average of 79 percent followed by Indonesia with the second highest turnover averaging 54 percent. Singapore analysis is inaccurate due to unavailability of data from 1990 until 1994.
growth. In the comparison of the five main ASEAN member countries, Thailand is the most volatile with an average turnover of 95 percent and followed by Singapore averaging 51 percent. Even though Thailand has one of the smallest stock market but owns a liquid stock market it proves to have a high turnover among the neighboring countries.
Company listed in stock market
From 1990 until 1997 the companies listed in stock market of each five main ASEAN members have increased substantially as illustrated in figure 9. The increase of each country varies in accordance of the economic condition. For instance the companies listed in the Malaysian stock exchange increased from 282 in 1990 until 708 companies in 1997 registering the highest increase with an average of 464.75 among the five main ASEAN members. Unlike Malaysia, Singapore is experiencing a slow growth throughout the period with an average of 204.
In 1998, only the total number of companies listed in Thailand’s domestic market experienced setback while others increased. Astonishingly as it may be, the volume of stock being traded and the size of the stock market declined whereas the turnover rate was high. Subsequent to the Asian financial crisis, the total number of companies listed in the stock market experience a slight volatile from the impact of external economic shocks. Nevertheless, the figure shows an upward trend.
Capital flow variable Capital inflow
among the ASEAN member countries. This phenomenon is triggered by the characteristic of the financial system which relies mostly on the banking sector to finance the country’s economy. However, in 1993 Thailand experienced an increase from 2.2 percent up to 4.4 percent capital inflow due to the substantial amount of FDI inflow into large scale basic industries such as steel and petrochemical sectors. As for the five main ASEAN member countries which consist of Indonesia, Malaysia, Thailand, Philippines, and Singapore, the capital inflow consist of foreign direct investment and portfolio investment. The amount of FDI itself in the main ASEAN member countries are quite large due to the financial and trade liberalization particularly in the manufacturing sectors. Meanwhile portfolio investment endured setbacks due to the lack of interest in the investment of stock market, securities, and bonds if compared to the amount of FDI inflow. This setback causes a decrease in the capital inflow representation to GDP. On the contrary, the post communist countries do not own portfolio investment that contributes to GDP due to the unavailability or lack of stock market that facilitate the investments of bonds, securities and stocks. Subsequently, the capital inflow only consists of FDI solely. Among the post communist countries, Laos has the highest development from 0.6 percent in 1990 up to 8 percent in 1997 due to Laos action in opening to the world and partly rely on foreign aid.
positive value of capital inflow valuing 6, 0.6, 0, and 7 percent, respectively. This is due to the new international emergence of each country which has small amount of foreign investment. Moreover, the fear of renewed political instability and a dysfunctional legal system coupled with government corruption discourage foreign investment such as in Cambodia. Nevertheless most of the investment in the countries runs to the tourism and small industries sector. On the contrary, Laos received $290 million from the IMF for economic aid and another $450 million in 2001 to support the government reform program to reduce poverty and rebuild infrastructure (IMF World Country Report). Despite the aid by IMF, Laos still endure a downward trend after 2000 due to weak fiscal policy and governmental infrastructure. Subsequent to the financial crisis, the government of ASEAN member countries imposed new monetary policies, renew macroeconomic foundations and cut business cost to revive its collapsed national economy. Among the ASEAN member countries, Singapore revived the quickest by 2004 averaging 15.77 percent of capital inflow to GDP.
4.2. Descriptive statistics result
The results of the descriptive statistics are presented in Table 1. ---TABLE 1 is about here---
4.3. OLS fixed effect results
The results of the hypothesis testing are generated by using OLS fixed effect model and supported by the t-test. This panel data fixed effects model is used to analyze the level of significance on the positive relationship between banking sector development and GDP per capita, the positive relationship between stock market development and GDP per capita, and the positive relationship between capital flow and GDP per capita.
omitted variable bias. The independent variables are liquid liabilities, credits to non financial private firms to GDP, credits to non financial private firms to domestic credit, commercial bank assets to commercial plus central banks assets, market capitalization, value trade, turnover, companies listed in domestic market, and capital inflow of FDI and portfolio investment. All variables are converted into logarithm so that the researcher interprets the coefficient regression as elasticity and the p value as the level of significance. In the first model (first column) the researcher regressed all of the variables to see the overall score. Then the least significance is omitted in the subsequent sequence of model until the most significant variables are left. The results will be interpreted model by model.
---TABLE 2 is about here---
The regression is supported by the R square value, level of elasticity (coefficients), and level of significance. The R square value is 0≤R2≤1 to explain the level of variance in the regression. In this research, the researcher considers the 0.05 significance level.
In the first model, the R square value is 0.428 which indicates that only 42.8 percent of the variance is explained in the regression. The first model shows that the overall banking sector development variables are statistically significant to economic growth. The first banking sector development variable, LIQLIAB is statistically significant with an elasticity of 0.179 (p value of 0.005). PRIVY is statistically significant with an elasticity of 0.082 (p value of 0.005). PRIVATE is statistically significant with an elasticity of 0.086 (p value of 0.001). COMMBANK is statistically significant with an elasticity of -0.094 (p value of 0.001).
0.736). Whereas the only capital flow variable, CAPINFL is statistically insignificant with an elasticity of 6.071 (p value of 0.766).
In the second model, the CAPINFL is omitted due to the least significance to economic growth. Despite the omittance of the capital flow variable, the stock market development variables still remain insignificant. However, even though the value of the significance level of the banking sector development variables alter it still remains significant to economic growth. Only 42.6 percent of the variance is explained in the regression. LIQLIAB is still statistically significant with an elasticity of 0.184 (p value of 0.041). PRIVY is statistically significant with an elasticity of -0.084 (p value of 0.002). PRIVATE is statistically significant with an elasticity of 0.087 (p value of 0.001). COMMBANK is statistically significant with an elasticity of -0.095 (p value of 0.001). Once again this indicates that the banking sector development is positively related to economic growth. On the contrary, the stock market development variables are still statistically insignificant which are going to be interpreted in the following. MKTCAP is still statistically insignificant with an elasticity of -0.012 (p value of 0.617). VALTRADE is statistically insignificant with an elasticity of 0.027 (p value of 0.413). TURNOVER is statistically insignificant with an elasticity of -0.026 (p value of 0.318). The last variable, COMPANY is statistically insignificant with an elasticity of -0.01 (p value of 0.775).
In the fourth model, the MKTCAP is omitted as it proved to be the least significant if compared to other variables. Also in this model, the R square decreased slightly to 0.423. Which means that only 42.3 percent of the variances are explained in the regression. Despite the low value of the R square, the banking sector development variables still remain significance. While the stock market development variables have not shown any significance yet. LIQLIAB is statistically significant with an elasticity of 0.196 ( p value of 0.022). PRIVY is statistically significant with an elasticity of -0.088 (p value of 0.000). PRIVATE is statistically significant with an elasticity of 0.091 (p value of 0.000). COMMBANK is statistically significant with an elasticity of -0.097 (p value of 0.001). On the contrary, VALTRADE still remains statistically insignificant with an elasticity of 0.11 (p value of 0.473). TURNOVER is also statistically insignificant with an elasticity of -0.15 (p value of 0.348).
In the fifth model, the VALTRADE is omitted as it proved to be the least significant if compared to the remaining variables. In this model also, the R square is 0.416, which means that only 41.6 percent of the variances are explained in the regression. The banking sector development variables are all still statistically significant to economic growth. LIQLIAB is statistically significant with an elasticity of 0.229 (p value of 0.002). PRIVY is statistically significant with an elasticity of -0.095 (p value of 0.000). PRIVATE is statistically significant with an elasticity of 0.093 (p value of 0.000). COMMBANK is statistically significant with an elasticity of -0.097 (p value of 0.001). The remaining stock market development variables, TURNOVER is still statistically significant with an elasticity of -0.009 (p value of 0.505).
The last model consists of only the remaining significant banking sector development variables left. The R square for this last model is 0.239 which is only 23.9 percent of the variances is explained in this regression. LIQLIAB is statistically significant with an elasticity of 0.062 (p value of 0.023). PRIVY is statistically significant with an elasticity of -0.021 (p value of 0.004). PRIVATE is statistically significant with an elasticity of 0.022 (p value of 0.005).
Referring to Table 10, there are three cases of multi-collinearity found after the Pearson correlation test. Subsequent to the test, VALTRADE and LIQLIAB seems to indicate multi-collinearity among each other with a coefficient of 0.831. The second multi-collinearity case is VALTRADE and MKTCAP with coefficient of 0.860. The third multi-collinearity case is PRIVATE and PRIVY with coefficient of 0.815. The caused of the multi-collinearity is because the four variables in respective case influence one another as they are almost similar to one another.
Concluding from the 7 models, only the banking sector development has a positive relationship with economic growth among the ASEAN member countries. The results of banking sector development (liquid liabilities, privy, private, and commercial bank) that are positively related to economic growth are consistent with some previous studies. The models that were founded by McKinnon (1973) and Shaw (1973) suggested that financial development would raise saving, capital accumulation, and economic growth. Odedokun (1996) employed time series data for 71 developing countries and showed that financial intermediation had promoted economic growth, in some 85% of the countries. Moreover, King and Levine (1993a, 1993b) used cross countries data to analyze the relationship between economic growth and the financial development. Their results had shown that a range of financial indicators are robustly positively correlated with economic growth. The banking sector development has a strong impact on accelerating growth due to the difference in financial infrastructure across countries. This suggests that a well developed banking system that improves the legal and accounting standards in the banking sector would facilitate financial development and therefore economic growth.
Chapter 5 Conclusion
Using the modified growth model, this study examined whether financial development promoted economic growth among the selected ASEAN member countries from 1990 until 2004. Specifically it focuses on two aspects of financial development which is the banking sector development and stock market development. This study extends this framework to include the measure of capital flow in the growth model. The main research question is formulated as follows.
“What are the effects of financial development on economic growth in the ASEAN member countries?”
The second hypothesis states that: there is a positive relationship between the development of the stock market and economic growth in selected ASEAN countries. Contrary to the prediction, it can be concluded that there is no positive relationship between the development of the stock market and economic growth. This result is in line with Naceur and Ghazouani (2006) that showed stock market development is not positively related to economic growth in due to sluggish and unbalanced growth in the MENA region which weaken any relationship between financial development and economic growth. This may be explained by the high degree of the high financial repression and weak equity market especially during the Asian financial crisis. As a result it cannot support a sustainable economic development in the countries. The lack of contribution of stock markets in the development process is mainly due to a new relatively and generally small capital markets in the ASEAN member countries. In other words, stock markets in the five main ASEAN member countries do not reach a threshold that will enable them to contribute to economic growth, except for Singapore. Singh (1997) also addressed that in most transition economies the regulatory infrastructure is badly developed. Therefore, the performance of monitoring, screening, and disciplinary role do not perform very well.
Chapter 6
Limitation and Further Discussion
This study focuses on the financial development and economic growth of the selected ASEAN member countries. Moreover, this study extends this framework to measure capital flow in the growth model. What needs to be mentioned, however, is that financial development and economic growth are very broad aspects and there are many factors influencing the growth model. In this section the limitations of this study and recommendations for further research will be given.
The focus of this research has been on the components of financial development, capital flow, and economic growth. Further research must use control variables such as political condition, population growth, trade, investments, and government consumption as they represent main determinants of economic growth but are not related to financial development. Furthermore, the research on financial development and economic growth on ASEAN member countries should have the complete set of countries. While, this research did not include Brunei Darussalam as one of the research object.
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Appendices
Appendix A Indonesia
Appendix B Malaysia
Malaysia achieved its independence in 1957. In the recent few decades, the Malaysian government has imposed development program which consist of the New Economic Policy, the National Development Policy, and more recently the Third Outline Perspective Plan. Subsequent to the appropriate policies applied and effective implementations, Malaysia successfully shifted the structure from agriculture and mining to manufacturing. Various kinds of liberalization measures were taken to increase competitiveness and productivity. Huge savings and export growth, coupled with political stability, ethnic harmony and proper liberalization in the financial system and trade regime, raised the status of Malaysia into the middle income level in 1980 (World Bank).
Appendix C Thailand
Appendix D Philippines
Philippines are known for its endowed rich mineral resources, largest resource of copper, gold, and chromites. The Philippines economy is diversified-its agricultural sector accounts for about 15 percent of GDP, the industrial sector 30 percent, and the services sector 55 percent. Once possessed as one of the region’s best performing economies, the Philippines’ per capita GDP growth has lagged behind fast growing Southeast Asian economies as of late. Besides having a lower GDP growth and higher population growth, the country is saddled with a large public debt and limited financial resources. The economy is also marked by great disparities in ownership of assets and in income, with tens of millions of people living in poverty.
Appendix E Singapore
A small densely populated island strategically located in the Malacca Strait between Malaysia and Indonesia, Singapore is regarded as one of the world’s most open, trade oriented economies. Serving as a regional headquarters for more than 3000 multinational corporations (MNCs), Singapore has world class financial, business and transport service sectors; a manufacturing sector anchored by electronics, chemicals, and engineering; a stable, honest government, and modern highly efficient infrastructure. MNCs account for almost 70 percent of manufacturing output, 45 percent of which are electronics components. The country consistently ranks high among most attractive countries or international business and has achieved a per capita GDP level comparable to levels of developed western nations. Singapore’s economy is heavily dependent on exports, particularly in electronics and manufacturing. As such, the economy remains vulnerable to external shocks.
Appendix F Vietnam
recover from three decades of wars after the reunification in 1976. Vietnam started economic reforms in 1986, targeting at moving from a planned economy to a market economy. Significant progress has been made in economic development since then, and the country became one of the fastest developing economies in the world. The agricultural sector (forestry and fisheries) still employs about 65 percent of the population, but its contribution to GDP has declined to about 20 percent in recent years from 40 percent in the early 1990s. The industrial sector has been growing rapidly and now accounts for about 40 percent of GDP, with relatively well diversified sub sectors of steel, mining (mainly oil and gas), garments, footwear, cement, and vehicle assembly.
Appendix G Myanmar
Myanmar’s economy relies primarily on agriculture, including livestock, fisheries and forestry, which accounts for about 54 percent of GDP. The country is gifted with extremely fertile soil and has important offshore oil and gas deposits. It is also the world’s largest exporter of teak and is a principal source of jade, pearls, rubies, and sapphires. Tourist potential is great but remains undeveloped because of weak infrastructure and international image which has been damaged by the junta’s human rights abuses and oppression of the democratic opposition.
Appendix H Laos
Laos is a landlocked, mountainous country, and is one of the world’s poorest and least developed countries. Subsistence agriculture dominated by rice farming, accounts for about 50 percent of GDP and provides about 80 percent of employment. Economic development is also constrained by inadequate infrastructure and a largely unskilled work force. With the introduction of its New Economic Mechanism in 1986, Laos has been gradually reforming its economy, transitioning from a centrally planned to market oriented system. Economic reforms and emerging from global isolation have helped the country achieve economic stability and increased growth. Such efforts have also helped boost levels of foreign direct investment and foreign trade. As a result, economic performance has been encouraging in recent years, with stable macroeconomic conditions and robust economic growth.
Appendix I Cambodia
Cambodia is one of the poorest countries in the world, with an estimated 75% of this country’s population occupied in subsistence farming. Similar to Philippines, Cambodia’s economic performance is lagging behind from the achievement that many of the country’s ASEAN neighbors achieved in the last quarter of century. The setback was caused by the decades of war and internal conflict that have ruined physical, social, human, and economic foundations necessary for growth and development.
Table 1 Descriptive statistics
N Minimum Maximum Mean
Std. Deviation
GDP per capita growth 135 4.45 4.80 4.65 0.05 Liquid Liability 130 1.59 4.96 3.80 0.85
Credit to Private Sector/GDP 102 -30.32 4.24 -4.15 3.91 Credit to Private Sector/Domestic Credit 102 -25.18 0.40 -3.27 2.87
Commerical Bank Assets/Commercial and Cental Bank Assets 130 -9.54 0.00 -2.82 2.91 Market Capitalization/GDP 75 1.67 5.80 4.10 0.97
Value of Stock Being Traded/GDP 75 0.82 5.44 3.22 1.16 Value of Stock Being Traded/Total Value of Stock 70 1.92 5.03 3.73 0.64
Company listed on stock market 75 4.83 6.87 5.75 0.49
Capinflow fdi pi and gdp 135 4.60 4.61 4.61 0.00
Table 2 OLS fixed effect
