Role of financial development for sustainable economic development in low middle income countries

https://doi.org/10.1016/j.frl.2022.102793Get rights and content

Highlights

  • We analyze the impact of financial development on sustainable economic development.

  • We use fixed effects, the feasible generalized least squares and bootstrap panel quantile regression to capture the results.

  • We consider two aspects of financial development – broad money and domestic credit to private sector.

  • We find that financial development positively affects sustainable economic development.

Abstract

This paper investigates the impact of financial development on sustainable economic development (SED) in low-middle-income countries. It adopts an unbalanced panel data approach on 50 low-and middle-income countries over the period of 1991–2020. We apply Fixed Effects (FE), the Feasible Generalized Least Squares (FGLS) and Bootstrap Panel Quantile Regression to analyze the results. We find that sustainable economic development is positively affected by financial development, natural resource abundance, international tourism, trade openness and foreign direct investment. Additionally, financial development plays a positive moderating role through natural resource abundance. Foreign direct investment (FDI) also enjoys a positive moderating role through international tourism. The Bootstrap Quantile outcomes point out the diversified effects of the addressed variables at different quantiles. Accordingly, it is crucial to consider financial development alongside socioeconomic variables such as trade openness, aging population and FDI to identify and address sustainable economic development issues.

Introduction

The world is currently facing critical social, environmental, and economic issues. Poverty alleviation, climate change management, economic inequality reduction and, more recently, pandemic danger mitigation all require enormous financial resources and expenditures (Pizzi et al., 2021; United Nations, 2017). Alongside sustainability threats, the COVID‐19 pandemic has worsened economies around the globe by increasing financial constraints. Lockdowns and isolation measures have increased uncertainty regarding production and economic outputs, whilst the significant shortfall for sustained financial policies continues to pose a crucial challenge (Iqbal et al., 2021). Accordingly, it is crucial to evaluate the contribution of financial development (FD), on a hand, and a range of socioeconomic factors, on the other, to sustainable economic development (SED).

Even if the mixed impact of financial development (FD) on economic growth is thoroughly investigated in the literature and, despite some counterarguments, the FD-growth nexus has witnessed a wide acceptance. In fact, the finance industry mainly contributes to long-run growth, influencing savings rates, investment decisions and technological innovation (Levine, 2005). Financial development triggers economic development through banks or equity markets (Beck and Levine, 2004) by collecting and pooling savings and allocating resources to industries that are expected to bring positive economic outcomes. Convergently, the micro-prudential and macro-prudential regulations are crucial for SED by allocating funds to structural transformation for green societies. Given the significance of policies and regulations on SED, some studies critically evaluated the role of FD through monetary transmission channels (Dafermos et al., 2018; Ishiwata and Yokomatsu, 2018) Shobande and Shodipe (2019) and Nabeeh et al. (2021) identified FD along with fiscal policy and credit as key-factors enhancing sustainable development. Finally, financial regulations effectively contribute to control physical resource distortion and preventing any negative impact on SED (Venables, 2016).

Recent studies have investigated the impact of FD on economic growth (see Appendix 1), noting a positive impact (Pradhan et al., 2013; Jedidia et al., 2014; Peia and Roszbach, 2015; Samargandi et al., 2015; Pradhan et al., 2017; Nguyen et al., 2019; Hunjra et al., 2021; Afonso and Blanco-Arana, 2022; Ali et al., 2022) despite some contradictory views (Eng and Habibullah, 2011; Mukhopadhyay et al., 2011; Demetriades and Rousseau, 2016; Boikos et al., 2022).

Nevertheless, the literature still suffers from a lack of evidence regarding the role of FD on SED in low-and-middle-income countries. The latter enjoys limited raising and access to capital because of lower savings rates; the capital limitation engenders a range of capital allocation problems across industries.

Despite the call for a cleaner production process shift to enhance sustainable economic development, even many industries require funding. These economies heavily depend upon the agriculture sector to intensify air and water pollution because of primitive technological setup (IPCC, 2014). Financial inclusion constitutes an important channel, where many developing countries are facing extreme climate change disasters affecting health and welfare. A better loaning policy could improve the access to credit for farmers, enabling them to adopt advanced technology and to more effectively face sustainability challenges (Georgopoulou et al., 2017; Singh and Dhadse, 2021). Financial inclusion (McKibbin et al., 2020; Shobande and Shodipe, 2020) promotes deposit and saving habits for positive investments for the well-being of these societies. However, due to low levels of savings, insufficient access to foreign loans and/or foreign direct investment, middleand-low-income economies struggle to fulfill financial needs. Given the financial constraints in these countries, an analysis of the financial development- sustainable economic growth relationship is crucially important.

An extensive literature addresses the relationship between international tourism and natural resource abundance, international trade, foreign direct investment (FDI), age dependency, and financial development. Despite the vast amount of studies, there are conflicting arguments concerning the role of natural resource abundance for economic development (Rostow, 1990; Amiri et al., 2019). Badeeb et al. (2017) evaluate natural resources as natural assets ownership, which include minerals, fertile land, and water sources that can be used for sustainable economic development attainment. The role of natural resources abundance is assumed to be positive with respect to economic development (Davis, 1995; Venables, 2016). Stijins (2005) considered mineral reserves and the volume of production and found a positive impact of resource abundance for economic growth. The study of Zhang and Li (2010) identified the importance of natural resources considering the resource prices and regional policy heterogeneity: the natural resource performance is slower for economic growth in central and western regions of China relative to eastern China.

Nevertheless, as discussed by the resource curse hypothesis, natural resource abundance does not guarantee SED (Sachs and Warner, 1995; Asif et al., 2020) as regions having excess natural resources remain, paradoxically, poor or underdeveloped (Dogan et al., 2020). Sachs and Warner (1995) validated the resource curse hypothesis around the globe. Considering the “paradox of poverty”, nations with natural resources abundance (specifically fossil fuels and rare minerals) enjoy slow economic development (Sachs and Warner, 1995; Badeeb et al., 2017) because of geopolitical, socio-politic and military induced instability. Uncertain natural resources prices and exploitation due to corruption appear as another crucial factor underpinning their paradoxical lower level of development (Abdulahi et al., 2019).

However, international trade increases sustainable economic development in-transition economies, through green technological spillover, exports promotion in goods and services, and capacity enlargement (Roquez-Diaz and Escot, 2018; Essandoh et al., 2020). In developing economies, FDI brings international mobility of capital and supports environment-friendly technology. The Pollution Halo Hypothesis supports the positive impact of FDI on environmental quality (Mert et al., 2020). The green technology transfer accompanied by FDI inflows and improvement in efficiency reduces environmental deterioration and improves sustainable development conditions.

Additionally, tourism has received much consideration due to its significant impact on increasing exports and triggering growth in many developing countries (Çiftçioğlu et al., 2021). Eyuboglu and Eyuboglu (2020), as well as Zaman et al. (2017), Zuo and Huang (2018) and Balli et al. (2019), confirmed the positive and significant impact of the tourism sector on growth in emerging economies. Nevertheless, Saint Akadiri et al. (2019) noted a mediating role of globalization through tourism on sustainable development.

Population aging is a global and critical threat to different economies of the world (United Nations, 2017; Dugarova, Gülasan, 2017). A significant association exists between the aging population and UN Sustainable Development Goals achievement (World Health Organization, 2015). Population aging deteriorates sustainable development and engenderes health and welfare issues. However, increasing inclusiveness and human resilience are listed among key UN SDGs (United Nations, 2017). There are alarming threats of population aging until 2050 and human dependency may arise as a result. Chapman and Shigetomi (2018) also report a negative and significant impact of population aging on sustainable development. The aging population is a burden in economies if human capital development strategies are not considered. Accordingly, when an economy is unable to fill in-demand vocations, it suffers from lower productivity, increased labor costs, delayed economic development, and lost international competitiveness.

Most studies focused on the above-mentioned areas, but the literature overlooked the combined effect of sustainable finance, international tourism, natural resource abundance, aging population, trade liberalization and FDI on the SED. However, the literature does not provide clear conclusions, especially in low-and-middle-income countries. Moreover, it overlooks the mediating role of financial development and various other socioeconomic variables from a holistic perspective. By focusing on the gaps in the literature we hypothesize that financial development, international tourism, trade openness, FDI and natural resources positively contribute to SED. We also suggest that financial development enjoys a significant moderating role on natural resource rents. Low-middle-income countries mostly have a younger population; thus, we expect a positive impact of age dependency on sustainable economic development.

The academic contribution of the present paper appears as three-fold. First, it considers the combined impact of the aforementioned socioeconomic variables considering the moderating role of financial development. Secondly, we investigate the impact of these variables at different levels of SED by adopting a novel approach, the bootstrap quantile approach. Third, we focus on quite extensive observation by endorsing a panel of 50 low-and-middle-income countries during the 1990–2020 period, able to support a holistic perspective on the finance-growth nexus.

This article r aims ato evaluating the role of financial development (FD) along with other socioeconomic variables on sustainable economic development. For the evaluation of the socioeconomic variables, we consider the impact of international tourism, natural resource abundance by adopting Fixed Effects (FE), feasible generalized least squares (FGLS), and bootstrap quantile approach. The next part of the paper presents the data and methodology, Section 3 provides the results and the final section makes some concluding remarks.

Section snippets

Data

We use a panel dataset including 50 developing countries over the 1991–2020 period. We focus on low-middle-income countries where sustainable economic development issues are prevalent and cross-country variation in financial policy remarkable. We collect annual data from the World Development Indicators (WDI) database of the World Bank. We have taken three years’ average approach to avoid missing data. The variable definitions are provided in Table 1.

Model

To test our hypotheses, we consider the

Results

Table 2 presents the descriptive statistics. The adjusted net savings mean value is 8.90. The mean value of GDP amounts to 1.68. The mean values of FD proxied by broad money (F1D) and domestic credit disbursement (F2D) to the private sector are very high, suggesting that companies enjoy easy access to financing. Thus, effective utilization of the loan facilities engenders or reinforces capacity for climate change mitigation, if different modes are introduced within green investment projects (

Conclusion

The present research contributes to the literature by exploring the role of social, environmental as well as economic/financial variables on sustainable economic development (SED). Its main outcomes confirm that financial development policies (designed and endorsed by governments) exert a highly significant impact on SED. Our results enrich the finance development-growth framework adopting a sustainable development perspective. Moreover, the article highlights a wider role of natural resource

CRediT authorship contribution statement

Ahmed Imran Hunjra: Conceptualization, Writing – original draft, Formal analysis, Methodology. Muhammad Azam: Conceptualization, Methodology, Writing – original draft. Maria Giuseppina Bruna: Methodology, Conceptualization, Project administration, Writing – review & editing. Dilvin Taskin: Conceptualization, Methodology, Writing – review & editing.

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