Finance-Growth Nexus: Evidence from a dynamic panel model on ECOWAS Countries.

Toussaint Houeninvo,


   Germain Lankoande,


The finance growth nexus dated back at least to Schumpeter (1911). Although the relationship has been strongly researched both theoretically and empirically since then, there is still no consensus among the Researchers on the issues (Esso 2010, Al-Malkawi and Abdullah 2011, Marwa and Zhanje 2015). In some conditions, empirical results have been found even conflicting namely during the financial crisis (Topcu 2016)

While the relationship has been extensively investigated in Developed and Emerging Countries, the literature on empirical studies related to the subject on African Countries in general and ECOWAS member countries in particular is poor. For instance Barajas Chami and Yousefi (2013) which used a dynamic panel Model for 150 countries over 1975-2005 with a Generalized Method of Moments techniques with differentiated effects by regions found that the effect of credit to the private sector on growth is non-significant for some regions such as Sub-Saharan  Africa  as opposed to regions such as “Middle East and North Africa”, “Europe and Central Asia” and “Latin America and the Caribbean” To our knowledge so far, the only study on the finance-growth on  ECOWAS countries is carried out by Esso (2010). It used times series data over 1960-2005 to investigate the co-integration and causal relationship between financial development and economic growth in the region. The Author who used real GDP as measure of economic growth and the ratio of credit to the private sector to GDP as measure of financial development, found that financial development leads to economic growth in two countries (Ghana and Mali), while growth causes finance in three countries (Burkina Faso, Côte d’Ivoire and Sierra Leone) and found a bidirectional causality in two Countries (Cape Verde and Liberia). The study found that the relation is non-significant in the other countries.

This paper uses a dynamic panel model on the fifteen ECOWAS Countries over the period 1960-2014 (54 years) applying Generalized Method of Moments (GMM) as econometric approach . To smooth out cyclical variation in growth of real GDP per capita and to comply with technical requirement of GMM according to which the number of periods should be smaller than the number of cross-sectional observations to avoid asymptotic imprecision and biases (Levine, Loayza and Beck 2000; Beck 2008; Roodman 2009; Barajas et al 2013), we construct 5-year average non-overlapping periods for each country. This leads 15 countries over 11 periods of 5-year averages.

 Using panel data offers several advantages including more informative data, more exploitation of time series and cross-section variation, more control for heterogeneity, less collinearity, more degrees of freedom and more efficiency (Baltagi 2005). Applying GMM techniques has the advantage of dealing with biases associated with simultaneity, endogeneity and lags of dependent variable and provide more efficient estimators (Loayza Beck and (2000); Beck and Levine (2004) and Barajas et al (2013)).

 Thus following Levine, Loayza Beck and (2000); Beck and Levine (2004) and Barajas et al (2013) models and based on Arellano and Bond (1991) and Arellano and Bower (1995) and Blundell and Bond (1998) econometric works, the Generalized Moment Method (GMM) estimator has been used to assess the impact of financial development on Growth on ECOWAS countries in a dynamic panel model.

The main research question is on the impact of financial development measured by Credit to the private sector on real per capita GDP. Subsidiary research question investigated on whether having a common monetary policy or a common currency or the legal origin (French vs British) has any indirect effect on growth through the channel of credit. The dependent variable is measured by the growth rate of real GDP per capita. Explanatory variables include credit to the private sector as percentage of GDP, a dummy variable for common monetary policy, common currency and a set of control variables such as direct investment as percentage of GDP, school enrollment, openness, inflation, government expenditure as percentage of GDP, previous level of real GDP per capita.

Based on the literature, the corresponding econometrics of finance and Growth model can be written as follows:

Where  is the real GDP per capita of country I in period t

 is the growth rate of real GDP per capita in period t

 stands for financial development variable (credit to the private sector)

 measures the effect of financial development on growth, the main focus of the paper

 measures the interaction terms (Interact) between financial development and one of the two sub-regional grouping (WAEMU and non WAEMU Countries) capturing Common Monetary Policy, common currency or legal origin. is the subsidiary focus of the paper.

 stands for a set of control variables other than the financial development , the lagged real GDP per capita and the regional dummy

which measures the effect of lagged income (or initial income in some cases) tests the convergence hypothesis

stands for unobserved country specific time-invariant variable

 is the error term, a white noise error with mean zero

All variables except the dummy are computed as the logarithm of their mean values over each 5-year periods.

The two requiring specification tests of the GMM estimator meaning the Sargan test of over-identifying restrictions which tests the overall validity of the instruments (lagged variables used as instruments) and the Allermo and Bond autocorrelation test which tests that the error term  is not serially correlated, validated the model.

The results of the model indicate that the credit to the private sector (financial development) is highly significant at 5% with the expected positive signs. The interaction of the dummy with the financial variable measuring whether a common currency or common monetary policy or legal origin (French vs English) exert any differentiated on growth through the credit to private sector  is not significant. As far as the control variables of the model are concerned, Government expenditure and the lagged real GDP per capital have positive and strongly significant effect at 1%, the later suggesting that the convergence hypothesis is not corroborate for the ECOWAS region.

This paper brings the following methodological and data improvement over the previous existing studies on the West Africa region: (i) in contrast to Esso (2010) its uses a real GDP per capita as dependent variable rather than real GDP; (ii) its uses Generalized-Method-of Moments in a dynamic panel method rather than time series in Esso study; (ii) the use of GMM allows to deal with biases related to time series and cross-country studies;(iii) it uses a set of control variable in addition to the credit to the private sector as opposed to using causality test between credit to the private sector and real GDP; (iv) it found positive effect of the credit on the growth of GDP per capita for the whole ECOWAS region as opposed to selected country and reversed causality for some of them and non-significant relationship for others; (v) it uses  update data covering 55 years over the period 1960-2014 as compared 46 years over  the period 1960-2005.

Overall, a 10% increase in credit to the private sector as percentage of GDP in ECOWAS leads to 6.4% increase in real GDP per capita. The common monetary policy, common currency or legal origin (French vs British) seems to have no specific effect on growth through the credit to the private sector on real GDP per capita growth in ECOWAS other than the direct effect of the credit itself.

These findings that are the first on ECOWAS member countries are consistent with results of several empirical studies. On the positive effect of access to credit by the private sector, the results are consistent with worldwide sample such as King and Levine (1993); Levine (1997); Levine, Loayza and Beck (2000a 2000b); Beck and Levine (2004). Common monetary policy or common currency or legal origin seems to make no difference in ECOWAS growth pattern. This is consistent with Levine, Loayza and Beck (2000a) study which found no significant effect for legal origin through the financial variable. Finally in terms of such a topic on regional regrouping, our results are consistent with Al-Malkawi and Abdullah (2011) study on Middle East and North Africa countries sample.

These results call for some policy recommendations including the following:

- Ongoing reforms to boost credit to the private sector (credit bureau, etc.) should be reinforced as they can be strong means to increase real GDP per capital and then leads to greater middle class in ECOWAS 

-The decision of Heads of States of ECOWAS to go to Common currency at 2020 should be conducted in parallel with reforms in the banking sector that can contribute effectively to an increase of credit to the private sector in order to promote economic growth. Otherwise, those reforms to a common currency may not have any impact of the growth of GDP per capita and the welfare of ECOWAS people.

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