A
substantial body of empirical work on finance and growth assesses the impact of
the operations of the financial system on economic growth, whether the impact
is economically large, and whether certain components of the financial system,
e.g. banks and stock markets, play a particularly important role in fostering
growth at certain stages of economic development. Patrick
(1966), in his work postulates a bi-directional relationship between financial evelopment and economic growth. Ever since, a
large empirical literature has emerged to test this hypothesis (see Levine,
1997 for survey). Two
trends in this respect have emerged in the literature.
The first tests the relationship between economic growth and financial
development, adopting a single
measure
of financial development and testing the hypothesis on a number of countries
using either cross-section or panel data techniques (Erdal, et. al, 2007 for
survey).
The second trend examined the hypothesis for a particular country using
time series data/technique, as done by Murinde and Eng (1994) for Singapore;
Lyons and Murinde (1994) for Ghana; Odedokun (1998) for Nigeria; Agung and Ford
(1998) for Indonesia; Wood (1993) for Barbados, and James and Warwick
(2005) for Malaysia. Other works by King and Levine (1993a, 1993b); Demetriades
and Hussein (1996) and DemirgüçKunt and Maksimovic (1998), structured on the
works of Bagehot (1873), Schumpeter (1912), Gurley and Shaw (1955), Goldsmith
(1969), and McKinnon (1973), employed different econometric methodologies and
data sets to assess the role of the financial sector in stimulating economic
growth. The mounting empirical research, using different statistical methods
and data have produced remarkable results. First, the results have shown that
countries with well-developed financial systems tend to grow faster, especially
those with
(i) large,
privately owned banks that channel credit to the private sector, and
(ii) liquid
stock exchanges. The level of banking development and stock market liquidity
exert positive influence on economic growth.
Second,
well-functioning financial systems ease external financing constraints that
obstruct firms and industrial expansion. Thus, access to external capital is
one channel through which financial development matters for growth because it
allows financially constrained firms to expand. The endogenous growth
literature supports the fact that financial development positively affects
economic growth in the steady state (Greenwood and Jovanovic (1990); Bencivenga
and Smith (1991); Roubini and Sala-I-Martin (1992); Pagano (1993); King and
Levine (1993b); Berthelemy and
Varoudakis (1996); and Greenwood and Smith (1997). Over the last two decades,
the literature has shown a growing body of new empirical approaches to treating
the causality pattern based on time series techniques Gupta (1984); Jung
(1986); Murinde and Eng (1994); Demetriades and Hussein (1996); Arestis and
Demetriades (1997); and Kul and Khan (1999).
In these studies, the focus is on
the long-run relationship between financial sector development and real sector
growth, using frameworks of bivariate and multivariate vector auto-regressive
(VAR) models for different country samples. The outcome was that the causality
pattern varies across countries according to the success of financial
liberalization policies implemented in each country and the level of
development of the financial sector. The Nigerian economy has from the
mid-1980s been moving towards increased liberalization, greater openness to
world trade and higher degree of financial integration. This policy stance and
other reform measures, particularly the banking sector consolidation exercise
of 2004/05 have led to enormous build-up of capital from both domestic and
cross-border sources.
Nigeria is, therefore, a veritable case for investigating
the link between finance and growth for at least two reasons. First, there has
been considerable increase in the activities of the financial markets prior to
the recent global financial crisis, particularly with regard to private sector
credit and stock market capitalization. Credit to the private sector, stock
market capitalization and the all-share value index were all on the upswing up
until the onset of the crisis. Second, Nigeria has an interesting history of
financial sector reforms. However, this proposal is not an agenda for this paper,
given that this is only an overview of developments in the two sectors – financial
and real.