Role of Financial Market in Asian Economies - Essay Example

The role of financial market in the process of economic development: Six Asian economies The development of financial systems is often characterized by the radical development of innovative financial system that allows an efficient allocation of resources, high level of economic growth and capital productivity. In the past, the impact of market development on economic growth has always been important issue. By exploiting the existing microeconomic theory of optimal financial system, economists have been able to analyze the relationship between economic growth and financial market development. For instance, Zhang (2003) and Hicks (1969) estimation were carried out to determine the relationship between economic growth and financial market. In this research we will use Christopoulous and Tsionas (2004) model, where the growth rate of GDP is dependent of financial development along side with other variable. Some of the countries in the Asian economy which will be considered are South Korea, Hong Kong, Taiwan, Pakistan and China. These countries will be focused in trying to study the contribution of financial market in the process of developing the economy. They all have similar economic development progress, culture and geographic proximity, thus making it possible to be used in determining the impact of financial market to the overall economic growth in a particular economy. The results will vary depending on the nature of the economic system, pattern of financial system and the type of model used to analyze the data. Introduction: A strong correlation that exists between economic growth and financial market is a well recognized fact which has received more attention by most economists. This can be supported by the revolutionary works of Walter Bagehot (1873) and Joseph Schumpeter (1912). Over time, the direction in financial markets has really evolved growth and a strong association of development with rapid capital increase. Generally, when there are no funds in a particular country, then, there is no incentive for economic development. Immediately after accumulation of funds and an increase in per capita, financial markets become very active with the emergence of the financial intermediaries that tend to grow in number and size. This economic growth has a positive change in the overall production level of goods and services in that particular economy. Most of the conventional economists suggest that, factors of production such as capital, land and labor are the key determinants of technological change and are the main source of change in the production function. It is obvious that a well functioning financial structure will encourages innovation of advanced technology that eventually results into economic growth. Countries that considered introducing the financial reforms in the year 1978 and 1990 respectively realized the benefits through economic growth and the well functional financial system. For example, China GDP increased by 10.5 % per year according to the IMF report in the year 2001 to 2010. In addition, to clearly understand this concept; a cross-country empirical model will be used is used. The rest of the paper is organized into four sections which are literature review in section 2, methodology section 3, data analysis & empirical results in section 4 and finally, the conclusion in section 5, whereby, the sections explain the relationship that exists in the countries. Literature review: In Zhang (2003), it analyzed eight East as well as Southeast Asian countries attempting to prove if financial development could really promote countries economic growth. The section of countries under review were Indonesia, Korea, Japan, Thailand, Philippians and Singapore covering the period between 1960 to 1999. Under the estimation model, financial development, stock capital, labor input and exports were used as explanatory variables. The Author defines financial development as the ratio liquidity liabilities to GDP and the estimating outcome of this analysis did not support the review that financial development promotes economic growth. It concisely includes author name and year, purpose of study, sample countries as well as sample period. Furthermore, the author defines financial development, and then estimates the model, different variables, findings and lastly the conclusion. According to Goldsmith (1969) under its pioneering study to determine whether finance exerts a relaxed influence on economic growth in the period of 1860 to 1963 the data for thirty five countries was found out to be divided by GNP. The results were that financial intermediary size is relative to the size of economic growth of each particular country giving a positive correlation between economic growth and financial development. This further lead to existence of more evidence on the relationship between the growth rate of an economy and its existing financial structure which has proven to be a challenging and controversial debate that is debatable by most economists. As argued by Barro (1992) that the financial system plays a major role in the overall industrial revolution. This has paved way for well functioning of the industrial system which encourages innovation of technology, thus, increasing funding to the firms that ultimately results into economic growth. On the other side, Friedman (1963) also suggested that the financial system developed due to economic growth. This provides an excellent overview of financial development (F) which is the level of countries progress and the economic growth. In addition, as argued in Burcu Kiran (2009), who examined the relationship between financial development and the resultant economic growth in the long run, he indicated a positive relationship between financial developments and the economic grow. Also this paper continues to employ the Pedroni Panel procedure with a series of consistent estimates of the relevant panel variables. The empirical results show a statistically significant and positive linkage between financial development and economic growth. For example, there is a well developed stock market in China, Unite Kingdom, Japan and Hong have a strong positive correlation with the economic growth. Furthermore, the paper discuses other key economic pillars such as stock market which contributes to economics growth in the developing countries and those that have already developed. The results provide an empirical support to the underlying economic theories in addition to stressing the role of human capital in the process of economic growth as argued by Barro (1992). The variables for the model are input labor, exports, stock of the market and financial development for the period between the years 1960 to 1985. In Burcu Kiran (2009), it examined the relationship between economic growth and financial development in the long-run for the ten emerging countries as well as the time period of 1968 to 2007, the result indicated a positive relationship in the long run between financial development and economic growth. In addition, King & Levine (1993) analysis for seventy seven countries for the period of 1960 to 1989; examined three economic growth indicators which are real per capita GDP growth, increase in capital stock per person and total productivity growth proved that a strong positive relation exists between each of the financial development indicators as well as the three economic growth indicators. Therefore, it is quite clear according to the above literature review on different scholar’s analysis, there exist a strong interrelation between economic growth and financial development. Methodology: In order to explain the relationship between economic growth and financial market development a number of variables will be considered. The hypothesis is always that, growth rate of GDP is dependent on financial development along side with some other important variables like international trade, capital stock and interest rate. Thus, country is the dependent variable represented by ‘Y’. The dependent of interest is the financial development. This can be relied upon in determining the relationship that exists between market development and economic growth. For instance, if we measure Y’s which are dependent on the financial development, then, its obvious the coefficient estimates must also be determined for the financial development and interaction dependence that is known to be positively significant. Based on the theoretical model, the financial development will automatically affect economic growth through two channels which are, development in financial sector that increases savings and intern leading to more financial investments. The other channel is an efficient resource allocation of the savings which flourishes the productivity of investment and savings (Shaw, 1973). Shaw also argued that the government policy that forces financial institutions to pay low rate of interest reduces the saving incentive of investors. This will ultimately lead to low investment and low economic growth. Other variables are international trade, capital and exports as agued by Beck and Levine (2004). Specifically, the significant contribution of the international trade to growth in China is a unique unquestionable factor for economic growth. Therefore, to estimate the relationship between financial development and market growth, the human capital augmented production function Cobb Douglas type will be employed. Our empirical analysis, the estimation model in the study is developed from Zhang (2003) In the following specification: Y=f (K, L, X, F, H) Where Y is aggregate real GDP, K is stocks of capital, L is labor input, X is exports, F is the level of financial development while, H is the human resources of higher education enrollment rate to population. In Zhang (2003) is likely to be subject the growth rate of the financial development (F) to a severe problem, which is almost to estimate for the growth of real GDP per capita. Thus, the author suggests F/Y, which is the ratio of liquidity liability to GDP. The annual growth rate or real stock for the liquidity liabilities at the year end is to measure the growth of financial development (F). On the other hand, it is always believed that H would contribute to economic growth. In Barro (1992) also suggests that the human capital would be an important factor in determining the economic growth. Based on this study, it shows the positive relationship that exists between the levels of initial per capita, GDP, education level and value of policy-related variables. The results indicate that there is a higher level of education achieved, faster rate of GDP per capita growth rate. Other than that, there is a positive effect of human capital on the physical investment as well as the negative effects of human capital on fertility rate with the overall education level. The study also examines the negative effects that the government intervention has on the development of financial system and economic growth. For example, government restrictions on banking system will slow down or reduce the process of financial development and eventually reduce the countries economic growth. This is because, low interest rates discourages savings, leading to a scarcity of investment funds and capital efficiency. Data analysis: The sample data is about the year 1990 to 2010 sourced from World Bank Development Indicator Online Database (WDI) as well as the Taiwan Ministry of Interior-Department of Statistics. This particular database provides the detailed statistics and information about Singapore, India, South Korea, China, Hong Kong and Taiwan. As explained both in the literature review and the methodology above, it is clear that any growth in the economy indicates development in the financial sector and has to contribute in the overall economic growth. In most cases, financial service work very well through an efficient resource mobilization as well as credit expansion in order to raise the investment level and efficient capital allocation. For instance, the hypothesis shows the relationship by using the resource mobilization as well as credit expansion channels. Using value of LD and LC for all the countries, a clear comparison is made. At the same time, a higher level of deposit has contributed to economic growth all the countries, though, an insignificant impact of the overall credit expansion on the economic growth which could have been attributed due to unproductive and inefficient allocation of resources. According to the model, the positive coefficient of R indicates that the economy can capture indirectly the effect of productivity on growth. For instance, if there is a negative coefficient of the interest rate, which implies that it is insignificant. This is contrary to expressionist school as argued by McKinnon (1973) and Shaw (1973). It is always advisable for R to be positively correlated with savings in any developing country because of a positive substitution that dominates a negative income effect. Bagehot Wong (2010) argument has shown that the development of stock markets in China, USA, United Kingdom, Japan and Hong Kong have a strong and positive correlation with their economic growth. The model has also brought out a key issue that stock market development is one of the important factors that contribute to the economic growth in developing countries and developed countries. If the coefficient R for any country is negative, then, it is clear that there are riskier or fewer investments opportunities other that existence of bank deposits. Therefore, it is advisable to consider saving in deposits rather than investing or using any other financial instruments. As argued by Barro (1992) who determined the relationship between human capital and the economic growth. He estimated that a large number of countries for educational attainment between the year 1960 to 1985. The results gave an important empirical support for economic theories, in addition to emphasizing the role of human capital in the economic growth process. In the estimation model, labor input, stock of capital, exports and financial development were used as explanatory variables. The author defined financial development as the ratio of liquidity liabilities to GDP and the estimating results of this study did not support the view that financial development promotes economic growth. If the ratio of deposits liability to normal GDP is more, then there is need to source more currency from abroad. Though, it is likely that the credit to private sector remain stagnant, even if the amount of deposit is increasing. The government can instead increase the savings in private sector by increasing the overall reserve. Countries like Hong Kong and Singapore are known to be the International financial center in the world; China’s Shanghai Stock Exchange as well as Shenzhen Stock Exchange, the India’s Bombay Stock Exchange, South Korea’s KRX and the Taiwan Stock Exchange Corporation (TWSE) are very active stocks, securities and futures market globally. On the other hand, since all the six economies have a lot of common characteristics, for instance, all are located in Asia and they are also having dramatic economic growth. In the near future, these economies might overtake the United States to become new global economic superpower. Conclusion: The main objective of the study is majorly to determine the relationship in the financial sector as well as their impact on economic and financial development in Asian economy countries. It has clearly represented the existing and the probable financial reforms to be considered in achieving the economic growth. In this paper, through the use of empirical evidence, simple model and cross-country panel data to evaluate the financial development has shown the relationship between the two. The empirical result has shown that, a sound financial development leads to economic growth (Levine, 1997. The study also expected that the financial market has independently a strong positive correlation with the economic growth. Therefore, an empirical investigation based on the study suggests that there are some interrelated implication policies for all countries even those which are still developing. As a way of effective competition in the market, it is advisable that more institutional reforms be brought into effect for an efficient resource allocation. This wills definitely create more profits in the economic sector leading to growth in the economy. The moderate increase in the ratio of deposit liability suggests that the government of any developing country has to maintain a positive and liberal positive interest rate in order to enhance savings and investments (Bagehot, 1873). In addition, other non-financial economic growth factors such as capital and trade are important in reinforcing the economic growth. More importantly, an increase in the deposits with negative and low interest rate encourages savings and even a well development of stock market, indicating a better opportunity for investment. Therefore, according to this research it is obvious that there exist a strong relationship between the economic growth and financial development. 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