Contemporary Issues in Development Finance - Essay Example

Contemporary Issues in Development Finance Table of Contents 0 Introduction 4 2.0 Literature Review 4 2 Theoretical studies 4 2.2 Empirical studies 6 2.3 Overview of Financial Development and Inequality in Vietnam 6 2.3.1 Financial development 6 2.3.2 Inequality 7 2.4 Assessment about the finance-inequality nexus 8 3.0 Empirical Model, Data and Methodology 8 3.1 Empirical framework 8 3.2 Data 10 3.3 Methodology 10 4.0 Empirical Result 11 5.0 Conclusion 12 6.0 Reference List 13 7.0 Appendices 14 Appendix 1 14 Appendix 2 14 Appendix 3 15 Appendix 4 15 Appendix 5 15 Appendix 6 16 1.0 Introduction Financial development is described as a method that marks enhancement in efficiency, quality, and quantity of the financial services. This process includes the dealings of many institutions and activities and is probably related to the economic growth. Financial development is also referred as the factors, institutions, and policies which lead to well-organized intermediation as well as effectual financial markets. A well-built financial system provides effectual capital allocation and risk diversification. The more the financial development, the advanced will be the enlistment of savings as well as its allocation to the projects of high return (Levine, 1997). Income inequality is described as the uneven distribution of individual or household income/earnings across the several participants in the economy. It is the sign of how the material resources are generally distributed across the society. High degree of earnings/income inequality is considered as undesirable. Measures of the earnings inequality relies on the data of disposable income of the household. The key indicator of earnings distribution is employed in ‘Gini coefficient’. The values of Gini coefficient scope between 0 (in perfect equality case) and 1 (in perfect inequality case). Poorer countries generally have elevated level of income inequality (Oecd, 2011). The main purpose of this paper is to empirically examine the connection between the financial growth and the income inequality by taking the example of Vietnam from the period 2000-2008. 2.0 Literature Review In the previous two decades, country like Vietnam has applied various economic and social reforms in order to encourage economic growth. The entrance of Vietnam into ‘World Trade Organisation’ in the year 2006 has concerned large inflows of foreign capital under the projects of foreign direct investment. Free trade and market-oriented financial system helped in releasing the capabilities and potentials of enterprises and individuals. Due to this, the economy achieved efficiency, higher productivity, and economic growth (C.M. Hoi and L.Q. Hoi, 2012). 2.1 Theoretical studies The connection between financial progress and the income inequality is a searched topic lately. Till now, two strings of notion, of which one pursue linear hypothesis and other follows non-linear hypothesis, are under exploration for the empirical evidence. Linear hypothesis: An overlapping model has been offered by Galor and Zeira (1993), who concentrated on the significance of the investment of human capital. They believe that there exist two sectors in an economy which produces a single good: unskilled-intensive and skill-intensive sector. Each one has two types of occupational options and that are to make investment in the human resources in the initial period and labour as skilled staff in the next period or to labour as unskilled staff for the entire life (Galor and Zeira, 1993). The model explains that at initial point, individuals are alike except the dissimilarity in the amount of original wealth inherited by them. Those with huge initial wealth have a propensity to make their investment in the human capital initially, work as experienced labour in the next period, earn or receive more, and also bequeath more. Those with small original capital tend to borrow to make investment in the human capital (Galor and Zeira, 1993). Making investment in the human capital is undividable, and also the borrowing is restrictive and costly because of the under progress of financial markets, therefore all of them cannot meet the expense of borrowing. Those who are not able to borrow stay as unskilled or inexperienced for their whole lives, earning less and donating/bequeathing less. In each generation, this cycle reiterate. So, initial or original wealth establishes the gap among the poor and the rich, and the income/earnings inequality is unavoidable (Galor and Zeira, 1993). When the economy begins to develop leading to growth of the financial markets, then the poor individual have more opportunities to borrow for the investment in human capital. Due to this, income inequality or disproportion begins to fall. This framework is called linear hypothesis. It proposes that in a nation where credit market is generally underdeveloped, there is a chance of higher income disparity or inequality. They further conclude that the income disparity must be negative in relation to the financial performance (Galor and Zeira, 1993). Non-linear hypothesis: Greenwood and Jovanovic (1990) created an intermediation framework, explaining a means through which the financial progress interplays with the income disparity/inequality. They presume that every agent of economy can follow any one investment opportunities, out of which first is safe however provides low return, and second is risky but gives high return. The intermediary services come up and helped in diversifying investment portfolio/group for any person who seeks to take part in intermediation projects. Initially, the financial sector was inadequately developed and the resources were also inadequately allocated, thus leading to humble economic growth. Afterwards, when financial intermediary came into practice, the resources turn out to be more productive and resulted in fast growing economy (Greenwood and Jovanovic, 1990). With the fast growing economy and at the fully grown phases of the economic growth, the financial/economic sector is fully modern and most individuals can access the financial services. A steady and stable state is achieved by the economy and therefore income inequality begins to get contracted (Greenwood and Jovanovic, 1990). 2.2 Empirical studies Till date, various empirical researches have been conducted to analyse different theories. In China, researchers have made use of yearly data from the period 1978-2007 in order to observe the connection between financial progress and the income inequality. They discover that financial progress have made affirmative contribution to lessen income disparity. The outcome supports the linear hypothesis but found minute proof to support the non-linear hypothesis. Liang (2006) ran regression analysis with a set of 30 urban Chinese zones for the period 1985-2000, discovers that income disparity is lesser in provinces which have enhanced financial sectors (Anwar and Nguyen, 2008). Some research has been done on economic growth and financial development in Vietnam. A panel record of 61 provinces have been analysed for the period of 1997-2006 and it was discovered that the economic development is positively related to the financial growth (Anwar and Nguyen, 2008). Lately, researchers found impact of the financial progress at the domestic level and they found enhancement of savings and investment on the households’ income level. However, none of the papers were concerned with showing the consequences of financial growth on the income inequality (Anwar and Nguyen, 2008). 2.3 Overview of Financial Development and Inequality in Vietnam 2.3.1 Financial development Recently, the financial market of Vietnam has blossomed. Statistical data which was obtained from surveys carried out by ‘General Statistic Office’ since 1993 revealed that financial enterprises’ number in the entire country gone up from 935 to 1635 during the period from 2000-2008 (See Appendix 1) (Dinh, 2010). Lately, Vietnam also showed fast growth in the sector of banking. The ‘State Bank of Vietnam’ (SBV) presents the role of supervising banking activities and monetary issues (Dinh, 2010). The aim of SBV is to stabilize the banking and financial businesses, prevent money laundering, manage price levels, ensure the security of financial and banking system as well as promote the socio-economic growth. The number of debit cards and credit cards rose twice in 2010 as compared to 2008 (Dinh, 2010). Bank lending is considered as another notable impression. The commercial banks which are state-owned primarily served the need of capital for the state owned ventures, and functioned as policy banking associations. However, now they are focusing on the commercial activities, challenging foreign banks. The commercial banks which are state-owned holds huge share of lending, resulting in 48% of entire loans in 2010, which has gone down from 2007. This shows that the commercial banks have become more active as well as it functions efficiently in the economy (Dinh, 2010). In terms of the monetary growth in Vietnam, statistical data of capital mobilisation, total liquidity, and credit presents the extraordinary figure in the growth of financial sector. Growth pace of these financial indicators augmented spectacularly from 2003-2007. Total liquidity’s average rates of growth were approx 28%, that of capital mobilisation was 31.75% and of credit was 35% (See Appendix 2) (Dinh, 2010). The years of lower rates reflects the flexibility and prudence of government in managing monetary/fiscal guidelines with regards to financing economic growth as well as managing price levels. The years showing higher rates indicates that government is following loose fiscal/monetary policy and promoting investment as well as development is more alarmed than inflation. The elevated growth rate in 2007 can be described by the inspiration of measures with Vietnam going into WTO in the year 2006 (Dinh, 2010). 2.3.2 Inequality The income inequality issue in Vietnam has gained a lot of attention from the researchers. For the entire country, the Gini coefficient, which is the general indicator stating level of income inequality, has augmented recently. According to General Statistic Office, the gap among the poorest and the richest is in the upward trend. The dissimilar coefficient of the income gap increased from 7.6 in 1999 to exact 9.2 times in the year 2010 (See Appendix 3) (Van and Akita, 2008). This strengthens the fact that income inequality is becoming awful in Vietnam. In general, the Gini coefficient shows an upward trend from the year 2002, as it is already more than 0.40, which is the level considered as unsafe by some scholars (See Appendix 3). The situation could be worse if no action have been taken before to evade unequal distribution of income. Recently, the urbanisation process is at high pace in Vietnam and it gives rise to the concerns about rural-urban gaps (See Appendix 4) (Van and Akita, 2008). In the large cities, urbanisation contributes more to the economic development and the aim of abolishing hunger as well as lessening poverty in the state. It leads to migration of huge number of people from country-side to the cities. Many of them who migrate usually work as the wage labourers, getting/earning more as compared to those colleagues who are self-employed or who work as rural farmers. Those people can flee from poverty or hunger only, but could not ease the disparity level between urban and rural areas as employers in the cities gain more profits from recruiting those migrants (Van and Akita, 2008). Therefore in Vietnam, urbanisation is comparatively low in spite of the fact that it is a developing nation. At present, the fraction of population is approx 30% which means that urbanisation will still continue and might be at a greater pace in the future when the financial system will be incorporated completely into world economy (Van and Akita, 2008). It has been examined that high degree of income inequality between urban and rural region could be there, and currently there is no means to prevent this situation. The findings indicate that the gap rises from 1999, decreases in the year 2006, and then again begin to rise (See Appendix 5) (Van and Akita, 2008). 2.4 Assessment about the finance-inequality nexus In the previous decade, Vietnam has gained fast development of the banking and financial sector. In contrast to it, the inequality situation in Vietnam seems to become worse. Though, if based on what is discussed earlier, it is complicated to know that whether there was a negative or positive relation between income inequality and financial development. For example, there was no difference in the Gini coefficients of the year 2008 as well as 2010 (See Appendix 3), while some main indicators of the finance like total liquidity and credit still increased significantly and are steady in the similar period (See Appendix 2) (C.M. Hoi and L.Q. Hoi, 2012). Researchers have found negative relationship among inequality and financial development. The regions having more financial progress commit a poorer level of income inequality, whereas, some found opposite trends in the relationship. To deliver exact conclusion on impact of the financial growth on the income inequality, it is believed that more comprehensive analysis methods are required (C.M. Hoi and L.Q. Hoi, 2012). 3.0 Empirical Model, Data and Methodology 3.1 Empirical framework An econometric model has been presented in order to assess the consequence of financial growth on inequality. Both the non-linear and linear hypothesis has been taken care of and test was done on whether both the hypotheses exist. In order to test the linear hypothesis, Gini coefficient framework is taken into consideration. It is regarded as the popular indicator which is used to compute the level of income inequality among population (C.M. Hoi and L.Q. Hoi, 2012). When Gini is equal to 0, it means that income is dispersed equally among every people, and when Gini is equal to 1, it signifies the state of complete inequality, which means that only one individual holds whole income of the society (C.M. Hoi and L.Q. Hoi, 2012). Financial development or growth is measured through various financial variables. At first, total liquidity and credit is used as substitute measures for the financial development. Though, the records at the regional/provincial level are very limited, therefore three measures were applied as substitutes for the financial development. Those alternatives are FD1, which is the proportion of total number of the financial companies over 1 million inhabitants of Vietnam in each province; FD2 is the average operational capital of the financial companies per head; and FD3 is the financial firms’ average fixed assets per head. Higher FD1 indicates a greater competition among the financial companies in order to capture the market share. So, the financial companies have enthusiasm to perk up their network, service quality, initiate improved technology and management, as well as consolidate the financial capacity in order to capture the share of the market and also to survive (C.M. Hoi and L.Q. Hoi, 2012). It leads to well structured financial markets in those places where advanced FD1 prevails. FD2 shows financial market capability in mobilising and exploiting capital for the financial company, whereas FD3 represents the development of the financial system in relation to its assets (C.M. Hoi and L.Q. Hoi, 2012). For the entire country, GDP has gone up along with the augment in the Gini coefficient. It indicates that rich people gain greater percentage of income or earnings from economic development than those who are poor. Therefore, it has been highlighted that the economic development in Vietnam encourages inequality. Both the non-linear and liner theories indicates that economic growth and finance move in similar direction, therefore in Vietnam whether the economic growth is equivalent to financial growth or not is still a matter of question. Trade openness is obtained by taking the values of exports and imports divided by the GDP, at provincial level as well as in the present price. Trade liberalisation creates more occupations for those sectors which are labour-intensive entailing that more unqualified labour would get advantage from the open trade. Dissimilar empirical works demonstrate different conclusions. It was found by Vivarelli (2007) that when the volume of trade is disaggregated especially by destination or origin, trading with the developed nations lead to great levels of income inequality in the developing nations. The rate of poverty indicates the percentage of inhabitants living below the poverty line. The city or province with higher rate of poverty means that there the inhabitants have less opportunity to reach to school, and also the education level in such provinces is low. The inequality of income could be poorer or worse for that province where the poverty rate is higher. Vietnam’s effort to eradicate poverty solves the matters of poverty and hunger as well as also assists in reducing inequality. Economic development is generally related to the financial growth. If economic growth and inequality is non-linear related, then financial growth may be non-linear linked with inequality (C.M. Hoi and L.Q. Hoi, 2012). 3.2 Data Researchers have conducted quantitative analysis by taking the data of total 59 cities and provinces of Vietnam for 4 years i.e. from 2002 to 2008 (See Appendix 6). Facts about financial companies are taken from the survey result which was conducted by the General Statistic Office for the period 2003-2009. The Gini coefficient was computed from “Vietnam Household Living Standard Survey” (VHLSS) by the researchers (See Appendix 6). The published report of the VHLSS 2002 includes surveyed information of 29,530 families, whereas, VHLSS 2004, 06, and 2008 include surveyed information of 9,189 families (C.M. Hoi and L.Q. Hoi, 2012). All the 4 surveys were meant for the regional or provincial level. Poverty rates were observed by the researchers from Yearbook of Statistics made by General Statistic Office in several years. Values of exports and imports to calculate trade openness level and financial growth were extracted from various sources for example Statistics Yearbook, socio-economic numerical figures of 63 cities and provinces, etc (C.M. Hoi and L.Q. Hoi, 2012). 3.3 Methodology A random effect and fixed effect model was applied in order to generate econometric outcome. Fixed effect framework/model has a benefit of being capable to explain the dilemma of the ignored variables over time which could have an effect on the dependent variable. Researchers have made use of random effect framework because with this model they can include variables which are related to time-invariant in the model. It permits the researchers to understand econometric outcomes of large inhabitants from small data sample. The Hausman experiment is used in order to identify which model or framework is more suitable. The main objective of econometric model was to assess the influence of financial growth variables on the income inequality symbolized by the Gini coefficient. At first, it is supposed to be negative. However, coefficient of rate of poverty is anticipated to be positive (C.M. Hoi and L.Q. Hoi, 2012). 4.0 Empirical Result On the basis of methods of random effects and fixed effects model as well as by using the data of Vietnam province, researchers have tested the continuation of non-linear and liner hypotheses in terms of inequality and financial development (C.M. Hoi and L.Q. Hoi, 2012). Then the Hausman measurement test is used in order to find out which model or framework is more suitable. Though, the approximated correlation between the error term and repressors is not minute enough to reject the model of fixed effects, so the researchers hold on to make use of fixed assets in order to read empirical outcomes. Consequently, all financial development’s coefficient is negative as well as statistically considerable at level 5% or 1%, which propose that the city with greater financial expansion commits lower income inequality (C.M. Hoi and L.Q. Hoi, 2012). A model of random effects is selected to describe empirical outcomes when accumulating rate of poverty in the model. Consequently, coefficients of the financial development are negative; entailing that financial growth/development actually has an encouraging impact on the income distribution. Moreover, these results present the explanation about the connection between inequality and poverty, province or city having higher rate of poverty would follow through having poorer inequality. The education is found to be extremely vital in minimising inequality and the openness also plays the similar role. Opposite to this, per head GDP fails to lessen income inequality. Concerning about the combined effect of the variables between financial development/growth and education, as well as financial growth and poverty, some interesting outcomes have been observed. The interaction’s coefficients between the financial growth and the education level are negative signifying that the city having both greater education level and higher financial growth/development would have lesser income inequality. Inequality of income would be greater in a city, which has both greater poverty rate and higher financial growth. The findings of various researchers indicate that there is a proof of the linkage between financial growth and income inequality and it reflected that it is linked with the income inequality. The empirical result supports the linear hypothesis, while the non-linear hypothesis did not gain much support (C.M. Hoi and L.Q. Hoi, 2012). 5.0 Conclusion The paper presents two different prophecies about the connection between income inequality and financial development in the theoretical studies. The empirical studies hold up linear hypothesis but further studies need to be carried to confirm about non-linear link between inequality of income and the financial development. The study makes use of information of 59 cities and provinces in Vietnam for the period of four years with the intention to scrutinize the connection between the financial growth and inequality of income. The outcomes support the linear proposition and it was analysed that financial growth can assist to lessen the level of inequality. Therefore, to drive the significance of financial division/sector in minimising income inequality; effective conditions and regulations for stabilising, developing, as well as reinforcing the financial sector are demanded. The outcomes of the research also put emphasis on the role of trade openness and education in minimising inequality, whereas an augmentation in per head GDP result a boost in Gini coefficient. Some errors were also found because of the inadequacy of data. Therefore, it is suggested that further studies should be performed with more data set to acquire more satisfactory justification about finance-income inequality nexus. However, the empirical assessment of the influence of financial growth/development on the income inequality assisted to understand the relationship between the financial growth and inequality of income in a better way. 6.0 Reference List Anwar, S. and Nguyen, L.P., 2008. Financial development and economic growth in Vietnam. Journal of Economics and Finance, 5(2), pp.28-34. Dinh, P.N., 2010. The impacts of financial development on household economic activities. Proceedings of the 1st Conference on Science and Technology: SBV Annual Report from 2003-2010. pp.34-56. Galor, O. and Zeira, J., 1993. Income distribution and macroeconomics. Review of Economic Studies, pp.18-33. Greenwood, J. and Jovanovic, B., 1990. Financial development, growth and the distribution of income. Journal of Political Economy, 2(1), pp.21-34. Hoi, C.M. and Hoi, L.Q, 2012., Financial development and income inequality in Vietnam: An empirical Analysis. Journal of Economics and Development, 14(2), pp.5-25. Levine, R., 1997. Financial development and economic growth: Views and agenda. Journal of Economic Literature, 32(2), pp.6-8. Liang, Z., 2006. Financial development and income distribution: As system GMM panel analysis with application to urban China. Journal of Economic Development, 4(1), pp.23-34. Oecd., 2011. Equity indicators: Income inequality. [pdf] Available at: < http://www.oecd.org/berlin/47570121.pdf> [Accessed 23 April 2015]. Van, C. and Akita, T., 2008. Urban and rural dimensions of income inequality in Vietnam. GSIR Working Paper – Economic development and policy series EDP, 08(2), pp.28-40. Vivarelli, M., 2007. Trade openness and income inequality in developing countries. CSGR Working Paper Series, 232(7), pp.36-55. 7.0 Appendices Appendix 1 (Source: Dinh, 2010) Appendix 2 Growth rate of total liquidity, credit and capital mobilisation by years (%) (Source: Dinh, 2010) Appendix 3 Facts about income distribution and inequality in Vietnam (Source: Van and Akita, 2008) Appendix 4 Proportion of population living in urban area (%) (Source: Van and Akita, 2008) Appendix 5 Gap between rural and urban areas (Source: Van and Akita, 2008) Appendix 6 Summary of major variables for the period 2002-2008 at provincial level (Source: C.M. Hoi and L.Q. Hoi, 2012) Read More