Financial Development and Economic Growth in Africa: A Cross-Country Evidence
No Thumbnail Available
Date
2023-02-04
Authors
Journal Title
Journal ISSN
Volume Title
Publisher
A.A.U.
Abstract
This study empirically examines the relationship between financial development and economic growth using a cross-country panel data analysis of 39 African countries. The aggregate economic growth indicator and the proxy variables for the financial development indicator are only considered for bank-based measures. To measure the level of financial development, the study uses two proxies, private sector credit to GDP and the index of financial development. Accordingly, the results show that the development of the financial sector has a positive and statistically significant effect on the economic growth of African countries for the two variables. The IV estimation results suggest that weak institutions and inadequate government regulation could distort economic decision-making and reduce productivity by hampering financial development. The finding also showed a significant positive coefficient attributed to the financial development indicator and the negative coefficient attributed to its squared value demonstrated the non-linearity of the relationship with financial development and growth. As a final point, the nonlinear relationship shows that when formulating economic growth strategies, we should consider the optimal level of financial development. The results for control variables suggests that foreign direct investment inflows, savings, trade openness, population and capital formation play important roles in boosting economic growth in African countries. However, increases in government size and inflation are detrimental to the economic growth of the same countries. Based on these findings, the study proposes the expansion of financial services through more lending to the private sector. The government should limit its size in the economy; savings in the economy should be channelled into productive investments; and it should manage the exchange rate and price of items in international trade to protect local producers and avoid imported inflation.