Stock markets, banks, and growth: Panel evidence

Thorsten Beck, Ross Levine (2002)

Edward Joseph, Jonas Rama, Jing Wang

Structure of Presentation
1. Paper introduction 2. Relating the paper to growth theory 3. Related growth theory to reality 4. Paper methods and results 5. Conclusion

Thorsten Beck, Ross Levine (2002) Objective

1. Confirm Positive Impact of Stock Markets and Banks on Economic Growth 1. Apply Recent Generalized-Method-of Moments Techniques Developed for Dynamic Panels.

Thorsten Beck, Ross Levine (2002) Findings

1. Stock markets and banks positively influence economic growth 2. Difficult to identify the specific components of the financial system associated with Economic Growth
Findings are not due to potential biases induced by: simultaneity omitted variables unobserved country-specific effects.

Solow vs. Ramsey Economic Growth Theory

Solow model
Savings = Investments. Investments = Depreciation The Steady State

Ramsey model
Accumulation of assets over time by households/firms. Saving and investing today allows for future consumption.

Realistically

Households and firms will seek higher than average returns.

Options for Investing & Raising Capital Stock (Bond) Markets & Banks

Stock market basics

Claim on future earnings Forward looking Market is efficient but is based on behavior of many players Inherently risky; potential for big returns Easy for households to understand
Investing in a company they know

Liquidity in SM allows for quick withdrawals

E

Measuring the stock market

Turnover ratio: (Total Trade / Listed Shares) Value traded: (Total Trade / GDP) Market Capitalization: (Listed Shares / GDP)

Bond market basics

A bond gives a fixed stream of payments over a given period to the holder.
Default risk Inflation risk

Certainty of final value of investment.

E

Bank Basics
Savings Accounts

Savings account is the safest option for cash (assuming low/no inflation; bank wont fail). Interest rate on account is based on central bank discount rate.
Consumers most comfortable with this option.

Loans
Banks take the deposits from their consumers and loan the money to firms or individuals. This allocates saved resources to their best use, given full information.
J

Measuring Bank Development

Bank Credit: (Private Deposits / GDP) The bank credit variable isolates bank credit to the private sector and therefore excludes credits by development banks and loans to the government and public enterprises.

Back to the paper

Thorsten Beck, Ross Levine (2002)
Conicting Theoretical Predictions on Financial Development & Growth:
Ameliorated Information
Lower Transaction Costs Better Resource Allocation Faster Long Run Growth

Enhance Resource Allocation

More Investment Opportunities

Lower Returns to Savings

Slower Long Run Growth

Empirical literature suggests: Banks accelerate economic growth, but w/out simultaneously examining Stock Market.

Thorsten Beck, Ross Levine (2002)

The Data & Preliminary Regressions

Panel of 40 countries and 146 observations. Data are averaged over ve 5-year periods between 19761998 in order to focus on longer-run relationships. G TR

Initial real GDP per capita (convergence)

(Exports +Imports)/GDP (trade openness)

Average years of education (human capital) Government expenditures to GDP

Black market premium (financial sector)

Ination rate

Thorsten Beck, Ross Levine (2002)

Methodology (Empirical Model)

Generalized-Method-of-Moments (GMM) Estimators Difference Estimator or the Two-Step GMM
First-Step assumes Homoscedastic errors Second-Step assumes Heteroskedastic errors

Alternative GMM
Sargan test Hypothesis test that error term is not serially correlated

Thorsten Beck, Ross Levine (2002)

OLS Results
Strong positive relation between Stock market development, Bank development, Economic growth. Signicance level bank development (bank credit) stock market development (turnover ratio) Both enter each of the ve regressions signicantly at the 0.05

Thorsten Beck, Ross Levine (2002)

1-Step & 2-Step GMM Estimator Results

To construct heteroskedasticity-consistent standard errors use 2-Step Estimator

Strong positive relation between Stock market development, Bank development, Economic growth. Results not due to simultaneity bias, omitted variables or country-specic eects. Signicance level w/ 2-Step Est. bank development (bank credit) stock market development (turnover ratio)

None of the other explanatory variables enters signicantly in the rst-step regressions

Thorsten Beck, Ross Levine (2002)

2-Step Alternative GMM Estimator Results

Fixing for over-tting asymptotic standard errors from the two-step panel estimator

Strong positive relation between Stock market development, Bank development, Economic growth.

Results not due to simultaneity bias, omitted variables or country-specic eects.

Signicance level except when controlling for trade openness (turnover ratio). Results suggest an independent link between Growth and both Stock Market liquidity (turnover) Bank Development (bank credit)

Thorsten Beck, Ross Levine (2002)

Conclusions
Data Consistent with Theories that emphasize Positive Role for Financial Development in the process of Economic Growth. Stock Markets and Banks Signicantly Traditional two-step system estimator, Significantly (except for trade openness) for Two-step alternative (reducing over-tting problem of 2-step estimator with heteroskedasticity-consistent standard errors) Stock Markets provide dierent nancial services from Banks, One-step system estimator, a more Cautious Assessment. Dicult to identify the specic nancial institutions associated with economic success.