Finance - growth nexus and institutions

This thesis examines the finance-growth nexus and the factors that may promote or mitigate this relationship, covering 107 diverse countries from 1986 to 2016. The selected factors are formal institutions, informal institutions, geographic-location, and income-level. Because financial development is a very multidimensional concept and the number of proxies is still expanding, reaching 38 proxies, a longitudinal analysis is employed in the first empirical approach where the autoregressive distributed lag model is employed for this time-series regression. The results confirmed that financial development promotes growth in the long-term, financial depth is a crucial pillar of financial development, and the finance-growth nexus differs slightly according to the proxies' selected. The effect increases when using depth indices and decreases slightly as the indicator expands to cover depth, efficiency, and capital market performance. The second empirical approach employs panel models, and the results confirmed the existence of finance-growth nexus. For the factor selected, the judicial effectiveness level endorses the finance-growth nexus, whereas the uncertainty avoidance level hinders this relationship which is aligned with the thesis assumptions that the lack of well-functioning legal frameworks affects the finance-growth nexus by abolishing trust, increasing risks, and decreasing interest in investing and opening new businesses. For informal institutions that reflect norms, values, beliefs, 'socially shared unwritten rules which shape individual and wider social behaviour. This thesis focused on the degree to which the members of a society feel uncomfortable with uncertainty and ambiguity. The results revealed that increased uncertainly avoidance results in a 3 less positive effect on financial development. Risk avoidance hinders the first pillar, 'financial depth', from promoting financial efficiency, which reflects the performance of financial institutions in lending and promoting investments. For geographic location and income level, the sign of the effect depends on the subgroup, where high´┐¢income countries, middle-income countries, and East and South Asian countries show a significant effect on the nexus. This thesis provides additional evidence on the positive finance-growth nexus by expanding the sample periods and countries to overcome the selection biases of the most current empirical analyses. It also provides novel evidence of the significant influence of informal institutions (culture) on the finance-growth nexus. Up to my knowledge, only a few researchers have examined the influence of cultural characteristics on financial structure whether it is bank based or market based, and others have examined the influence of the financial structure on economic growth. This thesis aims to contribute to this research and also thoroughly explains the multidimensional dilemma in which the financial development concept is still expanding. However, most current literature has employed one or more proxies supported with relevant literature without assessing all the proxies. Finally, the effect of financial development varies from country to country, and it is greatly beneficial for policymakers to know which factors may hinder the positive effect of financial development before conducting and implementing any development plan to promote the financial sector.