Chapter 2 Literature Review
Economic growth is a goal and national development policy of
every nation. Developed economies provide living evidence of the importance of
the financial sector in economic growth. Financial development stimulates
economic growth through investment which invariably contributes to increasing
national productivity.
2.1 Financial development: a factor for economic
growth
The positive correlation between financial development and
economic growth has been recognized in the literature for over decades Bagehot
and others Bagehot (1873), Schumpeter (1912), Goldsmith (1969) are among the
pioneers of this topic. Financial structure quickly became one of the
fundamental economic developments spurred by authors Gurley and Shaw (1967);
McKinnon (1973), King and Levine (1993). In almost all studies, findings
confirm that an efficient financial system contributes strongly to economic
growth. The correlation between the two variables is widely accepted however
the direction of causality is yet debatable. The concept of financial system
generally includes banks and financial markets. Levine (2004) advanced five
arguments that theoretically support the existence of strong and positive link
between financial development and economic growth. He stated that financial
system would:
· Cushion against the risk;
· Allow optimal allocation of resources;
· Allow better control of the company management
· Facilitate the mobilization of domestic savings;
· Facilitate the exchange of goods and services.
Schumpeter (1911) argued that an efficient financial system
greatly helps the growth of a nation's economy. For him well-functioning banks
encouraged technological innovation by offering funding to entrepreneurs that
have the best chances of successfully implementing production processes for
innovative products. Goldsmith (1969) is another pioneer in studying the links
between growth and financial development. His study focused on a sample of 35
countries over the period 1860 to
1963. He concluded that there is a positive link between the
financial sector and economic growth. In an attempt to address the weakness in
the work of Goldsmith, King and Levine (1993), focused their analysis on a
sample of 80 developed countries over a period 1960 to 1989 by reviewing all
financial factors likely to influence long-term economic growth and concluded
that there was statistically significant and positive contribution of financial
variables on economic growth.
Levine and Zervos (1998) assessed the impact of exchange stock
market and development of the banking sector on economic growth with a sample
of 49 countries over the period of 1976-1993 and using asset turnover, and
market capitalization ratios, market volatility and bank development indicators
as financial variables. They also considered as growth rate of real GDP,
capital, productivity and savings as endogenous variables in line with earlier
studies; King and Levine (1993). Their result highlighted the positive impact
of financial variables on economic growth and penciled two mechanisms through
which financial development is affected economic growth. The first is the
increased efficiency of capital, through better resource allocation, and the
second is the mobilization of savings which increases the volume of investment.
They concluded that economies with high levels of financial development
exhibited higher growth rates. Venet et al. (1998) in a study on the economies
of sub-Saharan countries from 1970-1995 found out that financial deepening
played a major role in the real growth of majority of countries within WAEMU,
including Cameroon. They used economic growth measured by real GDP per capita
as regressor and ratios of M2 to GDP, the nominal credit to the private sector
and stock of real credit per capita as financial variables and concluded that
there was a causal link between financial deepening and real economic growth of
the countries except Niger. In its case, there was no causal significance; yet,
according to them, the result does not necessarily imply the absence of
economic ties between the two sectors of Niger.
| 
