The Effect of Financial Development on Economic Growth in the MENA Region

Abstract

This paper provides new evidence that sheds light on the effect of financial development on economic growth in nine MENA countries over the period of 1991-2009. The empirical results using the Fully Modified Ordinary Least Squares (FMOLS) and Dynamic Ordinary Least Squares (DOLS) estimators reveal financial development is a statistically significant determinant of economic growth, but the impact is more apparent on stock market development than banking sector development. This finding suggests that improving the functioning of the banking sector is crucial to spur economic growth in MENA countries.(ProQuest: ... denotes formulae omitted.)1. IntroductionThe relationship between financial development and economic growth has been the subject of increasing attention. A growing body of empirical research has found evidence of a robust relationship between financial development and economic growth, which supports the endogenous growth literature that stresses the significance of financial development for long-mn economic growth (see Goldsmith 1969; King and Levine 1993; Odedokum 1996; Levine and Zervos 1998; Beck et al. 2000; Chang and Ho, 2001; Arestis et al. 2001; Chang and Caudill 2005; Eita and Jordaan 2007; Law 2007; Apergis et.al. 2007).While the majority of empirical studies show that there exists a positive relationship between financial development and economic growth, it is surprising that empirical studies from the Middle East North Africa (MENA) region are limited as well as the fact that the empirical results are mixed. For example; Al-Awad and Harb (2005) point out that financial development and growth may be related in the long run but their results fail to clearly establish the direction of causality. Using a composite index of bank development and stock market development, Naceur and Ghazouani (2007) find that overall financial development is unimportant or even harmful for economic growth in the MENA region. According to Abu-Bader and Abu-Qam (2008), finance leads to growth in five out of the six MENA countries they studied which were Algeria, Egypt, Israel, Morocco, Syria, and Tunisia. Another study by Rachdi and Mbarek (2011) demonstrates that there is a long-term relationship between financial development and economic growth, but the causal effect is running from economic growth to financial development. In contrast, Kar et al. (2011) point out that there is no clear consensus on the direction of causality between financial development and economic growth for all measurements of financial development in MENA countries.On the other hand, when looking at the growth performance and financial development indicators in the MENA countries in recent years, two observations are noteworthy. First growth has fluctuated more and increased weakly since 1991. Secondly, financial development indicators (which include the banking sector and the stock market) have fluctuated and rose during the last decade.The objective of this study is to examine the effect of financial systems on economic growth in MENA countries namely Egypt, Iran, Jordan, Kuwait, Malta, Morocco, Oman, Saudi Arabia and Tunisia during 19912009. This study extends on the literature by making several important contributions. Firstly, the relationship between financial development and economic growth has been studied widely in different countries, but only a few empirical studies have been conducted for the MENA region (Al-Awad and Harb 2005; Naceur and Ghazouani 2007; Abu-Bader and Abu-Qam 2008; Rachdi and Mbarek 2011; Kar et al. 2011). However, their studies are mainly based on banking sector development indicators except Naceur and Ghazouani (2007), who used a composite index of the banking sector (two indicators) and stock market indicators (three indicators) for an unbalanced panel data from 11 MENA region countries. Therefore, this study fills the gap by employing both banking sector (three indicators) and stock market (three indicators) development indicators as financial development measures that each one is analyzed separately. …