The panel data analysis of financial integration - economic growth nexus in developed and developing countries

This study is aimed to investigate the relationship between financial integration and economic growth using panel data techniques for 80 developed and developing countries over the period 1984-2010. Moreover this study examines how the composition of capital flows (foreign direct investment, portfolio equity investment and debt flows) and threshold conditions (financial development, institutional quality, trade openness and macroeconomic stability) effect the financial integration-economic growth relation. This study employs both rule-based (de jure) and quantity-based (de facto) financial integration indicators. Quantity-based financial integration indicators consist of foreign direct investment, portfolio equity, debt and total liabilities, and gross assets and liabilities. In this study, the capital movements are represented both as a flow and as an accumulated stock variable. Results show that rule-based financial integration variable positively affects economic growth. Findings indicate that more financially integrated countries grow faster relative to less financially integrated ones. The effect of capital flows on economic growth depends upon the composition of capital flows, research period and the region of the country. Foreign direct investment and portfolio equity liabilities positively affect economic growth while debt stock negatively affects economic growth. The capital flows in the form debt liabilities have negligible even negative effect on economic growth. These results support the composition hypothesis which asserts that the types of capital flows have different effects on economic growth. The empirical literature on financial integration-economic growth nexus generally uses gross assets and liabilities stocks as a financial integration indicator. The effect of gross assets and liabilities stocks on growth is negative. Empirical results show that the foreign capital flows support economic growth, but domestic savings are more important than foreign capital for supporting economic growth. Moreover, the effect of capital flows on income level is higher than the income growth. The level effect of capital flows is more important than the growth effect. The financial crises during the research period (Latin America, East Asia and 2008 global financial crises) and boom-bust cycles in the capital flows hamper the growth effects of capital flows. After the 1990's when the crises intensified the positive impact of capital flows especially foreign direct investment on economic growth decreased. The costs of crises suppress the positive growth effect of capital flows. The positive relation between capital flows and economic growth is stronger in 1980's and, in East Asia-Pacific and Latin America region and, in developed countries relative to the developing countries. This study has limited evidence about threshold hypothesis in the financial integration-economic growth nexus. Moreover types of capital flows have different threshold conditions. The effect of foreign direct investment on growth depends upon the level of macroeconomic stability of country. High level of inflation decreases the positive impact of foreign direct investment on economic growth. The growth effect of foreign direct investment increases as the level of macroeconomic instability decreases. Foreign direct investment is sensitive to the structural macroeconomic factors such as the level of inflation, budget balance, current account balance and growth rate. Findings show that the negative effect of debt stocks on economic growth decreases as the level of financial development increases. Dominant evidence indicates that the relationship between financial integration and economic growth appears to be generally linear and, the interaction effects don't apply to the every type of capital flow. The effects of financial integration on economic growth are not contingent on the threshold conditions.