Manufacturing and Services Growth in Developing Economies: ‘Too Little’ Finance?

Abstract

This article explores the relationship between financial development and growth in manufacturing and service sectors in 77 developing economies over the period 1984–2013. Specifically, we examine whether the size of the financial sector matters and if it does, whether the size of the financial sector in these countries is of a sufficient scale for credit and liquidity expansion to benefit the economy. Using the two-step system generalized method of moments, we find a u-shaped relationship between either manufacturing or services growth and financial size, indicating that a critical level of financial scale has to be achieved for financial expansion to positively affect the growth. For some 50%–90 per cent of the economies in the sample, there is a robustly long-run adverse effect of financial expansion on both manufacturing and services growth, indicating a case of ‘too little’ finance, likely explained by a combination of weak institutions, market failures and the existence of large and lumpy investments that require sufficient financial scale.

Aspects of financial development and manufacturing and services growth: Which matter?

“…Moreover, we find that different aspects of FD matter. In terms of the usual of credit and liquidity indicators (i.e., private credit and bank credit), we find that there exists a critical financial scale that has to be attained before further financial expansion can have a positive effect on manufacturing growth in developing economies, in line with Daway‐Ducanes and Bautista (2019). In line with Arcand et al (2015), we find that the IMF's broad‐based FD indicators (in terms of either overall FD indicator, the FI or FM sub‐index or in terms of either the FM or FI sub‐indices for depth, access or efficiency)—have positive, but diminishing effects on either manufacturing or services growth.…”

“…To serve as bases for comparison, we also use the following measures of credit and liquidity in Daway‐Ducanes and Bautista (2019) and that are often used in the literature: Bank credit, defined as credit extended by banks to the private sector (as a percentage of GDP). This FD measure has been used in several studies including Levine and Zervos (1998) and Beck and Levine (2004).…”

“…On the other hand, and specifically in the case of developing countries, Daway‐Ducanes and Bautista (2019) find evidence of “ too little finance.” Financial liquidity and credit expansion have a negative impact on long‐run manufacturing and services growth in around 50 to 90% of 77 developing economies in the period 1984–2013. Their findings suggest an overall lack of financial scale, possibly due to weak institutions and market failures, that hinder the financing of large, lumpy, growth‐generating investments 3…”

Financial development and economic growth in sub-Saharan Africa: A sectoral perspective

“…In contrast, the service and industrial sectors may attract good projects and the environment may prove more conducive for such projects. Some have however argued that the service and industrial sectors are capital intensive and therefore the level of financial development would have to be higher to realise a positive effect on growth (see, for example, Daway-Ducanes & Gochoco-Bautista, 2019).…”

“…This study complements existing literature by examining the impact of financial development on sectoral growth. Though there are some studies with a focus on sectoral growth, they rely either on a single measure of financial development or are country-specific (for example, Asaleye et al, 2018;Daway-Ducanes & Gochoco-Bautista, 2019;Ogbonna et al, 2020;Oliynyk-Dunn, 2017). This is significant because this study argues that the impact of financial development on growth may vary across different sectors of the economy.…”