The Effect of Financial Development and Institutional Quality on Economic Growth in Member Countries of the Organization for Economic Cooperation and Development

اقتصاد و توسعه منطقه ای

Article 2, Volume 26, Issue 17, November 2019, Pages 33-62   

Document Type: مقالات پژوهشی

DOI: 10.22067/erd.v26i17.68020

Authors

ali ahmadpourkacho^* ; nazar dahmardeh

University of Sistan and Baluchestan

Abstract

Extended Abstract
Introduction
Today, it is believable for the majority of economists that both physical and human capital accumulation  and technological changes are unable to fully explain the difference of economic growth rates between countries. What which mentioned recently as the main key for economic growth in the literature are institutional quality and financial development. The particular importance of institutional and financial structure in economic growth has been at the frontier of research for recent decades. Various studies have emphasized the critical role of institutional quality reform in financial and economic development since it provides the necessary base for more efficient allocation of financial resources. Regarding institutional quality, it is an essential and necessary condition to enhance financial development, so in this context, suitable policies are demanded. Good governance improves the allocation of resources and increases the impact of financial development on growth. In other words, the effectiveness of financial development in order to achieve economic growth increases with the improvement of governance.
 
Methodology
The main aim of this paper is to study the effects of financial development and institutional quality on economic growth for the case of 27 member countries of Economic Development and Cooperation Organization (OECD) in 2002-2014, using Dynamic Panel Data analyses. In this paper, we used a weighted average of six indicators of accountability and accountability, political stability and lack of violence, government efficiency, order and regulation quality, rule of law and corruption control as an institutional indicator, and a weighted average of 18 variables, extracted from the World Bank, for the combined financial-financial development index. Statistical data of the variables, GDP to labor ratio, financial development indicators, gross fixed capital formation and work-force growth rate have been extracted from the World Development Index (WDI), and institutional quality indicators have been extracted from Worldwide Governance Indicators (WGI).
Results and Discussion 
Institutional quality is another important factor affecting economic growth, and its significant positive coefficient suggests that institutional quality is one of the key variables that influences the economic growth of OECD member countries.
 The significant positive effect of institutional quality on the economic growth of OECD member countries is in accordance with the theoretical and empirical results of studies on these countries; because these counties have high ratings in institutional variables such as the quality of bureaucracy, the right to comment and responsivity and rule of law, which that highlight their improved judicial system, executive system and civil liberties and hence the institutional quality. The coefficient of the variable of financial development index in the estimating models shows that the weighted average of financial development indicators has a significant positive effect on the economic growth of OECD member countries. By reducing transaction costs and accessing information, the financial sector has led to equipped savings and facilitated funding. This, in turn, has resulted in higher investment and faster economic growth. This result is consistent with theoretical foundations (supply-side view) of financial development and economic growth. This positive effect indicates that the economies of OECD countries have the necessities and benefits of favorable financial markets that respond to the needs of the economy, including the goals of liberalization, privatization and balance and development, and in this regard, yields many favorable and preemptive effects for different sectors of the economy. Part of these favorable effects of financial markets, and in particular the capital market, stems from the efficient functioning of financial institutions in the financial markets of OECD countries, and the other huge part stems from the environment of the economy, and economic-social and cultural-legal structures of these countries. Accordingly, the interactive effect of financial development and institutional quality has been inserted into the model to measure the efficiency of financial development in the shadow of institutional quality on the economic growth of OECD member countries. The coefficient of the interactive effect of financial development and institutional quality also indicates the significant positive effect of financial development on the economic growth of OECD member countries.
 
Conclusions & Suggestions
The findings of this paper showes that financial development and institutional quality have significant positive effects on the economic growth of OECD member countries, which is in line with the expected theory in Economic Growth. Also, the interactive effect of financial and institutional development showes that in developed countries due to proper institutional structure, financial development improves economic growth. According to our results, in the case that countries want to make major changes in their economic growth, they need to address institutional reforms in different sectors. Therefore, in order to facilitate economic activities and achieve economic progress, the policy makers of the studied countries must have a simultaneous attitude toward the economy and politics, and make their policy with the presumption that  two factors, financial development and institutional quality, reinforce each other and have a positive impact on economic growth.
 

Keywords

institutional quality; Financial development; Economic Growth

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