ABSTRACT
The study examines the nexus between financial development
and economic growth in Ghana over the period 1970-2013. The stationarity test
result shows that the order of integration of variables included in the model
was a mixture of I(0) and I(1). Therefore the study employs the bounds testing
approach to cointegration and error correction models developed within the
Autoregressive Distributed Lag (ARDL) framework to explore the long-and
short-run effects of financial development on economic growth. The study uses
five different measure of financial development including, credit to the
private sector, narrow money, broad money, ratio of narrow money to broad money
and domestic credit. The study also investigates whether there are other
determinants of economic growth. Evidence of both long-run relationship and
short-run dynamics was found amongst the various financial development
indicators and economic growth. Precisely, the results showed that credit to
the private sector, ratio of narrow money to broad money, narrow money, broad
money and domestic credit influenced economic growth in the long-and short-run.
Again, inflation and government consumption expenditure were found to impede
economic growth in the long-run and short-run. Contrarily, capital stock, trade
openness and FDI were found to stimulate economic growth both the long-and the
short-run. When credit to the private sector was used as an indicator for
financial development, financial sector liberalisation was positive. The study
recommends that policy makers should take caution in the choice of financial
development indicator as a policy instrument for the attainment of growth and
development. Again on the basis of empirical evidence, policies to improve the
accessibility of affordable credit by the private sector, including small and
medium scale enterprises should be enforced.
CHAPTER ONE
INTRODUCTION
1.1 Background of the study
Globally, a delicate concern of
every economy is the attainment of greater heights in the level of growth and
development through positive changes in production levels of goods and
services. The attainment of sustainable levels of economic growth is a core
macroeconomic objective of an economy. Empirically, some traditional factors
and the distinct interactions amongst each other have been identified to play a
crucial role or increasing levels of growth (see Solow, 1956). Among these can
be mentioned, capital, labour and land. Notwithstanding this, the new theories
of growth have also identified technological changes as a key driver to the
engine of growth as it stimulates productivity.
Over the years the relevance of an
efficient and adequate financial system has also been recognized to play a role
for increased levels of growth (see Sala-i-Martin, 1992; King and Levine, 1993,
Easterly, 1993, Khan and Senhadji, 2000 and Khan et al 2005). This is
buttressed by the fact that a sound financial system not only contributes to
economic transformation but also creates an enabling environment conducive for
the mobilization and allocation of funds geared towards increasing patterns of
growth and development (Levine, 1997). Schumpeter (1911), McKinnon (1973) and
Shaw (1973) also note that an economy with an adequate and efficient financial
system tends to experience increased growth patterns as it encourages various
technological innovations. It is for this reason amongst many others that most
developing countries opted for reform programs in their financial sectors
during the eras of economic imbalances in various sectors of the economy
including the financial sector.
Development
in the financial sector is the instance that makes an improvement in the
quality, and efficiency of financial intermediary services. More specifically,
development in the financial sector implies adequately utilizing, financial
resources in mobilizing and allocating resources to prioritize development in
the real sectors of an economy (Aryeetey et al., 2000). For most developing
countries the introduction of various economic reforms including financial
reforms was basically aimed at reaping the benefit of high rate of economic
growth obtained from a well-developed, effective and efficient financial
system. Ghana is no exception to these groups of countries that have
implemented some economic reforms when faced with major set-backs in its
financial sector.
Prior to the implementation of the
sector-wide reforms of the financial system, Ghana financial sector was faced
with financial repression and/or shallowing and hence causing its failure as an
intermediary to the attainment of growth levels in real sectors (manufacturing
and agriculture) of the economy (Adu et al., 2013). Ghana introduced the
Financial Sector Adjustment Program (FINSAP) in 1988 to help liberalize the
financial sector which was challenged in the early 1980s. This exerted a
significant and positive effect on various financial systems hence the growth
of the economy over the years of implementation. For instance, during the
period, there was a significant increase in the banking sector as the number of
banks in the economy increased relatively compared to the pre-liberalisation
periods. Specifically, the number of banks in country rose from ten with 405
branches in 1988 to twenty seven with 696 branches by 2009 (Adu, et al., 2013).
In addition, the banking sector of the economy became more vibrant with the
increase in total bank assets from approximately 0.31% of GDP in 1993 to
approximately 0.66% by 2008. Following the implementation of the FINSAP, there were
appreciable upswings in various financial indicators including, capital
adequacy, savings/deposit mobilization, interest rate liberalisation, sectoral
credit allocation, asset allocation and concentration amongst many others.
1.2 Problem Statement
Controversies surrounding the role
of the financial system to the engine of economic growth have caused the
finance-growth link hence cannot be overlooked. Despite the fact that there
have been various perspectives on the relationship between financial
development and economic growth in terms of causation, literature shows that
various economists hold different perspectives. Patrick (1966) states two major
hypotheses that explain the causal link and its direction exiting between
finance and economic growth. These include, the supply-leading hypothesis and
the demand following hypothesis.
The former perceives a
unidirectional relationship running from financial development to economic
growth with no feedback effect. In other words, economists supporting this
argue that the establishment of efficient and adequate financial systems,
markets and institutions will cause relative increase in the supply of
financial services thereby leading to increasing patterns of economic growth.
Various empirical studies, including Mckinnon (1973), Levine et. al., (2000),
King and Levine (1993a, b), Levine, (2004), Neusser and Kugler (1998) and
Ogwumike and Salisu (2009) support the supply-leading hypothesis. Contrarily,
the demand-following hypothesis posits that the causal link is from economic
growth to financial development. Intuitively, followers of this hypothesis also
argue, as an economy grows, there is a relatively high demand for financial
services hence causing improvement in the financial sector. Meaning, financial
sector development is positively related to increasing growth patterns.
Empirically, there have
various studies supporting the demand-following hypothesis (see Gurley and
Shaw, 1967; Goldsmith 1969; Jung, 1986).
Although there have been various
cross-sectional and panel studies in various countries (King and Levine, 1993,
Fernadez and Galetovic, 1994 and Saci, et al. 2009). However there is an
assertion that cross-country studies are unable to reflect country specific
results mainly due to the act that, different countries pose different
economic, social, political and institutional characteristics (Arestis and
Demetriades, 1997; Rousseau and Wachtel, 2001 and Rioja and Valev, 2004). In
this vain, it can be noted that it will appropriate and relevant to conduct a country
specific analysis rather than a panel analysis on the finance-growth nexus.
Furthermore, literature search has
shown that only few studies have been conducted in Ghana. (see Quartey and
Prah, 2008; Esso, 2010 and Adusei, 2013). Quartey and Prah (2008) uses four
financial development indicators (broad money as a ratio of GDP, domestic
credit as a ratio of GDP, private credit as a ratio of GDP and private credit
to domestic credit ratio) to investigate the bivariate causal linkage among
financial development and economic growth. Esso (2010) also conducts a study on
the relationship between growth and financial sector development on a panel of
ECOWAS countries including Ghana. The researcher used credit to the private
sector as a sole measure of financial development. Adusei (2013) According to
literature it is reasonable to argue that there is no single indicator that
could be considered as an adequate measure or proxy for financial development
in country. Hence for every economy, there should be a relative large set of
proxies for the level of financial development. This study will not only fill
the lacuna of increasing the time period but will also
consider five different proxies of financial development including credit to
the private sector, ratio of narrow money to broad money, narrow money, broad
money and domestic credit.
It can hence be noted from the
aforementioned discussions, that an in depth analysis of the nexus of financial
development and economic growth in Ghana is required.
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