China Economic Review 17 (2006) 395 – 411
Financial development and economic growth: Evidence from China Qi LIANG a,b,*, Jian-Zhou TENG c,d
Department of Finance, School of Economics, Nankai University, Tianjin, 300071, China Graduate School of Commerce and Management, Hitotsubashi University, Kunitachi, 186-8601 Tokyo, Japan c Graduate School of Economics, Hitotsubashi University, Kunitachi, 186-8601 Tokyo, Japan d School of Mathematics and Statistics, Northeast Normal University, Changchun, 130024, China Received 17 April 2005; accepted 26 September 2005
Abstract This paper investigates the relationship between financial development and economic growth for the case of China over the period 1952–2001. After considering the time series characteristics of the dataset, a multivariate vector autoregressive (VAR) framework is used as an appropriate specification and the long-run relationship among financial development, growth and other key growth factors is analyzed in a theoretically based high dimensional system by identification of co-integrating vectors through tests of over-identifying restrictions. The empirical results suggest that there exists a unidirectional causality from economic growth to financial development, conclusions departing distinctively from those in the previous studies. D 2005 Elsevier Inc. All rights reserved. JEL classification: C32; O11; G28 Keywords: Financial development; Economic growth; Multivariate VAR; Causality; China
1. Introduction The economic growth of China is remarkable since the outset of the reform program in early 1980s. A great number of theoretical and empirical studies have explored the sources of economic growth at both national and provincial levels (e.g., Borensztein & Ostry, 1996; Chen & Feng, 2000; Chow, 1993; Chow & Li, 2002; Wu, 2000; Yu, 1998), and ongoing debate is mainly concerned with which source, factor accumulation or productivity improvement, is the * Corresponding author. Department of Finance, School of Economics, Nankai University, Tianjin, 300071, China. Tel.: +86 22 2350 8717. E-mail address: email@example.com (Q. Liang). 1043-951X/$ - see front matter D 2005 Elsevier Inc. All rights reserved. doi:10.1016/j.chieco.2005.09.003
Q. Liang, J.-Z. Teng / China Economic Review 17 (2006) 395–411
key growth-driving factor. However, unfortunately, the role of financial development in economic growth has till recently often been ignored, with a conspicuous lack of studies being made to theoretically examine and empirically determine this. The effects of the financial sector on real economy can hardly be over-emphasized, as Goldsmith (1969, p. 390) puts bone of the most important problems in the field of finance. . . is the effect that financial structure and development have on economic growthQ. On one hand, it is difficult to investigate various aspects of the finance-growth nexus since simply examining the correlations among them, which are utilized in most cross-country studies, can lead to spurious estimations due to a number of limitations inherent in the cross-sectional technique.1 Besides, it is well known that correlations reveal nothing about causation. On the other hand, the majorities of the existing time-series studies applying only bivariate causality tests between indicators of financial development and growth variables (e.g., Bell & Rousseau, 2001; Calderon ´ & Liu, 2003; Demetriades & Hussein, 1996)2 also suffered from the omitted variables bias and could lead to erroneous causal inferences, since any causality test between financial development and economic growth which excludes other decisive growth determinants from the system and analyzes only a financial development indicator and an output variable, is very likely to be misspecified, and little reliance could be placed on the results of such studies. There are, to the best knowledge of authors, only a few studies using multivariate causality test in the...
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