Relationship Between Financial Liberalisation And Economic Growth Economics Essay

Introduction to the Study

Background of the Study.

The relationship between fiscal liberalization and economic growing has received a considerable attending in recent theoretical and empirical surveies. McKinnon ( 1973 ) and Shaw ( 1973 ) and later Kapur ( 1976 ) , Mathieson ( 1980 ) and Fry ( 1989 and 1995 ) have presented the theoretical model for this relationship. The chief policy deduction of the McKinnon-Shaw model is that authorities limitation on the fiscal system like involvement rate ceiling, high modesty demand and directed recognition policies stifles fiscal deepening and hence cut down economic growing. However, the impact of fiscal liberalization on the beginning of economic growing has non been decently investigated. One of the earlier grounds in this way was provided by Levine and Zervos ( 1998 ) . They estimated the relation between the beginnings of growing and step of stock market integrating based on the plus pricing theoretical accounts.

The literature on the political economic system of fiscal liberalization and development, nevertheless, stresses the distributional effects of fiscal development[ 1 ]. Rajan and Zingales ( 2003b ) are of the position that liberalised fiscal markets provide resources to new entrants, who can so do other markets competitory. On the other side, fiscal underdevelopment means that entree to economic chance is limited for those outside the incumbent elite ( Ibid ) . Acemoglu and Robinson ( 2000 and 2002 ) argue that authoritiess stand foring little military, industrial and fiscal elites, which would endure economically from increased competition and accordingly face an eroding of their political or fiscal powers, may therefore oppose fiscal reforms and development, thereby curtailing the entry of new domestic and foreign rivals[ 2 ].

Fiscal Liberalisation ( FL ) is expected to impact positively on economic growing and development straight at the national degree and indirectly at the single degree. Levine ( 1997 ) stresses that the fiscal system promotes more effectual exchange of goods and services every bit good as mobilises single and corporate nest eggs. It besides promotes more efficient allotment of scarce resources and promotes monitoring of corporate direction through capital markets and leting for hazard pooling. Goldsmith ( 1969 ) , McKinnon ( 1973 ) , Shaw ( 1973 ) , and Fry ( 1995 ) are of the position that without these mediators, investing or hazard taken might non take topographic point, technological advancement is likely to be held back and economic growing might be slower. In other words, the fiscal system helps to raise excess financess from those whose current income exceeds their current ingestion and redistribute them to people or concerns who need them to put as loans or credits to those who want to convey forward ingestion against future income and profitable investings.

Many economic experts acknowledge that the administration of the fiscal system is important to economic development and that the fiscal system can actively assist to advance economic growing and development, but if it is ill organised could halter growing and development. This averment is implicitly based on the dominant position that the working of fiscal markets ( i.e. fiscal establishments ) can be portrayed as intermediation between rescuers and investors. Based on this position, for at least the past 20 old ages, both neo-classical economic experts and World Bank/IMF representatives have been reding LDCs to liberalize their fiscal sectors. They argue that FL can take to increase in nest eggs, higher investing, and therefore rapid economic growing. Furthermore, they assert that the remotion of limitations on international capital minutess have on some occasions been welcomed as a growing chance and in others, blamed for triping fiscal instability and crises.

Typically, fiscal liberalization in developing states has been associated with steps that are designed to do the cardinal bank more independent, relieve fiscal repression by liberating up involvement rates, leting fiscal invention, reduces directed and subsidised recognition, allows greater freedom in footings of external flows of capital, every bit good as leting aliens to merchandise in domestic stock market and the citizens trading in foreign stock markets.

Most of the recent literature on fiscal liberalization and developments has hence focused on the ground why some states remain financially developing. There are a figure of possible grounds for differences in fiscal development across states, loosely falling into three interconnected groups. First, the literature on establishments and administration emphasiss that fiscal establishments require a legal and regulative environment in which contracts can be decently enforced and bankers are given strong inducements and support to act decently [ see for illustration Kaufmann et Al ( 1999 ) , Demirguc-Kunt and Detragiache ( 1998 ) , Andrianova et Al ( 2003 ) ] . Second, the literature on jurisprudence and finance is of the position that specific types of legal system are more contributing to protecting investor rights and accommodating the jurisprudence to take into history fiscal invention[ 3 ].

There is, nevertheless, grounds that states with more inhibitory political governments have experienced slower development of fiscal markets but there is so far no direct grounds that less democratic authoritiess intentionally prosecute policies ensuing in fiscal underdevelopment. Such policies are frequently summarised in the term “ fiscal repression ” , which refers to a mixture of involvement rate controls, high modesty demands on Bankss, directed credits, controls on capital influxs and control over the domestic stock market. Control over fiscal resources can besides be achieved by province ownership of Bankss ( Rajan and Zingales, 2003b ) . On the other manus fiscal underdevelopment may merely be a consequence of a policy of disregard, where authorities neglect to make the institutional model necessary for fiscal development to take off, such as regard for the regulation of jurisprudence, unafraid belongings rights, low degrees of corruptness every bit good as competent and effectual prudential ordinance and supervising. Furthermore, Rajan and Zingales ( 2003b ) argue that a authorities ‘s failure to make the establishments that underpin successful fiscal development is a “ calculated act of skip ” and indicates a “ policy of malign disregard ” intended to continue the privileges of officeholders. Similarly, Oechslin ( 2005 ) shows that a low grade of creditor protection may be a deliberate policy to switch resources towards oligarchic elites.

On the other manus, a little but turning literature such as Van Winjnbergen ( 1983 ) and Stiglitz ( 1994 ) are of the position that fiscal markets imperfectnesss like asymmetric information and imperfect competition means that fiscal liberalization can hold a negative consequence on economic growing and development.

Aims and hypotheses of the Study.

The thesis will look into and supply penetration into the impact of fiscal liberalization both involvement rate liberalization and capital history liberalization on sustainable economic growing in Primary Commodity Exporting Countries ( PCECs ) , viz. Ghana, Nigeria and Niger all being members of the Economic Community of West African States ( ECOWAS ) every bit good as look intoing the being of currency permutation currency in these states. The empirical analytical method of autoregressive distributed slowdown ( ARDL ) – bounds proving attack.

Aim of the Study

The aim of this thesis is to happen out the impact of fiscal liberalization policy on economic growing in PCECs in an environment of currency permutation ( see above ) . The aim is stated in four creases. First, the thesis will look into the being of currency permutation in the three states[ 4 ]. Second, the thesis will set up the being of the McKinnon-Shaw hypothesis in the selected states. Previous state surveies in this country have produced assorted consequences. Third, the thesis will further look into whether capital history liberalization leads to economic growing in PCECs. At the minute there are really few state surveies in this country for the selected states. There are nevertheless, empirical grounds from other parts of Africa. ( see for illustration Naceur, Ghazouani and Omran, 2008 ) . Finally, the thesis will besides look into and seek to set up whether fiscal liberalization leads to sustainable economic growing in PCECs given the secular impairment of term of trade of primary trade goods and the monolithic portion of export in the gross of these states.

Hypothesiss of the Study

The McKinnon – Shaw hypothesis postulates that remotion of involvement rate ceiling will take to increase in nest eggs and therefore growing. In order to accomplish the aims of the thesis, I will prove the undermentioned hypotheses for PCECs utilizing clip series informations from Ghana, Nigeria and Niger. The hypotheses to be tested are:

That liberalization of involvement rate is expected to take addition in official currency permutation.

That liberalization of involvement rate is expected to take to increase in investing via additions in nest eggs and therefore economic growing.

That stock market liberalization is expected to take to economic growing

That fiscal liberalization is expected to take to prolong growing of the non-export sector in PCECs.

Hypothesis 1 will prove for the being of currency permutation in the selected states. Hypothesis 2 will prove for the relevancy and impact of the domestic or involvement rate liberalization on nest eggs ( investings ) and hence economic growing. Hypothesis 3 will prove for the relationship between capital history liberalization and economic growing and hypothesis 4 will prove for the being of long term sustainable economic growing in financially liberalised PCECs. Even though much empirical and theoretical work has been done on fiscal liberalization in LDCs as a whole, non much attending has been devoted to the complications ensuing from Currency Substitution and the consequence of the non export sectors in PCECs. Almost all the empirical work so far expression at the impact of fiscal liberalization on money supply and economic growing but for PCECs what is likely important is the impact of fiscal liberalization on the growing of the non export sector of the economic system ( i.e. the outwardnesss generated by the export sector ) .

Significant of the Study.

Most of the old surveies completed on fiscal liberalization and economic growing are based on grounds from Latin American and the East Asiatic states with small attending devoted to African states, particularly, primary trade good states in the part. This has let to a state of affairs where in most of these surveies, writers have investigated the impact of fiscal liberalization on the growing of Gross Domestic Product ( GDP ) and the money supply and their other signifiers ( See for illustration the undermentioned empirical surveies of Goldsmith ( 1969 ) , Jung ( 1986 ) , Roubini and Sala-i-Martin ( 1992 ) , De Gregorio and Guidotti ( 1995 ) , Odedokun ( 1996 ) , Luintel and Khan ( 1999 ) , Benhabib and Spiegel ( 2000 ) , Deidda and Fattouh ( 2002 ) , Odhaimbo ( 2005a ) , Odhiambo ( 2005b ) , Shrestha and Chowdhury ( 2007 ) , Onaolapo ( 2008 ) , Odhiambo ( 2009 ) , Ogunmuyiwa and Ekone ( 2010 ) and other such empirical surveies among others ) instead than the growing of the outwardnesss ( non-export sectors ) in the economic system generated by the export sector in primary trade good states. For PCECs, this is likely, the chief failing of the old surveies as the impact of fiscal liberalization on economic growing can non be efficaciously established with exports of primary trade goods being the chief subscriber or generator of economic growing. The possible failing of this research will be that the consequences should be applied to non PCECs with cautiousness.

There has been really few empirical analysis of the impact of currency permutation on nest eggs and hence investing in an environment of fiscal liberalization in most African states. This thesis will lend to the literature on fiscal liberalization, foremost by set uping the being of currency permutation and so by look intoing its impact on the economic sciences growing via its influence on nest eggs and investings of three West African primary trade good exporter states. This research will be original in the sense that it will try to set up the being currency permutation every bit good as set uping the relationship between currency permutation, fiscal liberalization and economic growing for PCECs which are known to be susceptible to secular impairment of footings of trade and immiserizing growing.

Furthermore, the thesis will lend to the literature on fiscal liberalization by look intoing the impact of fiscal liberalization on sustainable economic growing as measured by the growing GDP and its other signifier as in the instances of all the old surveies. However, in add-on to the above, the research will try to set up the long term relationship between fiscal liberalization and the growing of the non-export sectors which is more relevant sector, fiscal development wise, in primary trade good exporter states.

Motivation for taking the Countries Selected.

The thesis will utilize clip series informations from three West African states, viz. , Ghana, Nigeria and Niger, for the empirical analysis. In add-on, they are all members of the Economy Community of West African State as good. The chief motive for choosing these states is hence their different features and similarities in their economic construction and location every bit good as the entire deficiency of empirical grounds on their fiscal liberalization policies particularly empirical grounds on Ghana and Niger.

These three states were chosen because they all depend to a great extent on primary trade goods export for a major portion of their foreign exchange gross[ 5 ]– Petroleum Oil provides Nigeria with approximately 90 % of the entire export gross. Cocoa beans and Gold provide about 70 % of the entire export gross for Ghana whilst Uranium provides about 80 % of Niger export gross.

Finally, the states were selected based on their fiscal systems. Ghana and Nigeria have their ain independent pecuniary governments, fiscal systems and currency whereas Niger is a member of the West African Economic and Monetary Union ( WAEMU ) which act as the pecuniary governments for eight states and portions the same currency with them.

Administration of the Study.

The thesis will be organised as follows. In chapter two, it will reexamine the bing empirical and theoretical universe literature on the relationship between involvement rate liberalization, currency permutation and economic growing. In the literature, involvement rate liberalization is supposed to take to an addition in nest eggs and investings and hence economic growing. However, in PCECs, the finding of nest eggs may be complicated by the fact that important proportion of domestic nest eggs may be in other signifiers than fiscal nest eggs and the fact that fiscal nest eggs is merely one signifier of nest eggs may hold some impact sing fiscal deepening and therefore the consequence of involvement rate liberalization on sustainable growing in an environment of currency permutation. The chapter will further analyze the theoretical statements against the involvement rate liberalization hypothesis.

In chapter three, the thesis will reexamine the relationship between capital history liberalization and economic growing. Capital history liberalization refers to a deliberate policy by which a authorities of a state allows aliens to take part in the domestic portions and bonds market and at the same clip leting domestic investors to merchandise in foreign securities. Supporters of liberalization argue that international capital flows will take to lower cost of capital, let for hazard variegation, and promote investing in undertakings with higher returns and leads to integration into the universe fiscal system. The chapter will further analyze the statements for and against capital history liberalization by reexamining the theoretical and the empirical universe literature on the effects of stock market liberalization on economic growing.

In chapter four, the thesis will reexamine the relationship between fiscal liberalization ( both involvement rate and capital history ) and sustainable economic growing in primary trade good exporters vis-a-vis their non export sectors. Many economic experts agree that favorable footings of trade have a positive impact on economic growing. This manifests itself in the signifier of addition in export monetary values relative to import monetary values which allow a larger volume of imports to be purchased with a given volume of imports. The implied addition in the existent buying power of the domestic production is the same as a transportation of income from the remainder of the universe and can hold big impact on ingestion, nest eggs and investings ( see besides Government Treasury, New Zealand, 2006 ) . However, in PCECs, the footings of trade is, nevertheless, argued to hold the inclination to deteriorate over clip ( Prebisch 1950, Singer 1950 ) . As a consequence of this the benefits ( economic growing ) , derived from the addition in existent buying power ( increase ingestion and increase nest eggs and investings ) should be reflected in the addition in the part from the non export sectors in order to keep sustainable economic growing.

In chapters five, six and seven, the thesis analyses the experiences of fiscal liberalization in Ghanaian, Nigerian and Nigerien fiscal sectors severally. The thesis will reexamine the bing empirical literature on fiscal liberalization in the selected states and employ assorted descriptive statistical steps to back up the analysis.

In chapter eight, the thesis will stipulate the empirical theoretical accounts for the analysis. To prove for the impact of involvement rate liberalization on economic sciences growing every bit wells as proving for the being of currency permutation utilizing an drawn-out theoretical account proposed by Shrestha and Chowdhury ( 2007 ) . In this theoretical account, a factor to stand for currency permutation will be introduced. Furthermore, a discrepancy of the theoretical account used by Naceur, Ghazouani and Oman ( 2008 ) will be employed to prove for the effects of capital history liberalization or fiscal development on economic growing. Finally, I will so stipulate a new theoretical account to prove for the effects of both involvement rate liberalization and stock market liberalization on sustainable economic growing ( from the non export ) in PCECs.

In chapter nine, utilizing clip series analysis, the thesis will use cointegration appraisal technique of bounds proving attack or autoregressive distributed slowdown ( ARDL )[ 6 ]for the econometric analysis. This is because the ARDL attack is simple, does non necessitate pre-testing of the variables and is comparatively more efficient in little or finite informations sizes[ 7 ].

Finally, in the last chapter, based on the result of the predating analysis and the context of the economic conditions in each of the selected states, the thesis will offer some decisions, deductions and policy recommendations.