The relationship between financial development and economic growth convergence

The relationship between the financial and the real sectors is important because there are conflicting views concerning the role that the financial system can play in economic growth. The reform of financial sector is expected to bring about significant economic benefits through a more effective mobilization of domestic savings and a more efficient allocation of resources. The outcome of such efforts have varied among countries and have been influenced by such factors as the speed of reform, initial financial conditions, and most importantly the design and sequencing of the reform package. This study reexamines the empirical relationship between long-run growth and financial development in the Middle East/North Africa (MENA) region. In particular, the study contemplates on filling the gap created by the absence of comprehensive studies investigating the determinant of growth in the MENA region. This paper explores the possibility that financial development serves as a convergence factor.We use an augmented Solow growth model with the financial sector as intermediation factor. The results of the theoretical model show that financial development accelerates the convergence process. The paper then presents the empirical results of growth equations, estimated with system-GMM (Generalized-Method-of-Moment) panel estimator. It was found that financial development has a positive effect on economic growth, and also increases the income per capita convergence speed toward the steady-state. The results of the model show that the neoclassical growth model has a substantial explanatory power for analyzing the role of economic policies that promote growth.

Keywords:

Solow growth model , income convergence , financial development , system-GMM panel estimator JEL: O4-O42-O47-O50