THE EFFECTS OF FINANCIAL DEVELOPMENT ON ECONOMIC GROWTH IN AFRICA: DOES THE QUALITY OF INSTITUTIONS MATTER?

Abstract

Purpose- The main objective of this paper is twofold. First, the paper aims to examine the effect of financial development on the economic growth of African countries. Second, the paper also aims to examine if institutional quality moderates the nexus between financial development and growth. Methodology- A panel dataset of 35 African countries over the period from 1985 through 2018 is used and to handle the problem of endogeneity and reverse causality the dynamic panel estimation method, GMM estimation, was employed to estimate the relationship while accounting for other control variables that affect economic growth. The data set was retrieved from World Bank world development indicators, international monetary fund, and International Country Risk Guide (ICRG). Findings- The empirical results of the study indicate that financial development has an ambiguous impact on the economic growth of African countries, but it has a significant positive effect on growth if interacted with the institutional quality index such as government stability, rule of law, and corruption. The interaction term between finance and institutional quality indicator is positive and significant, implying that the positive effect of financial development depends on the level of institutional quality of the country. Conclusion- To sum up, in countries where institutional quality is high, the effect of financial development on growth is higher compared to countries where institutional quality is low. This indicates that improving institutional quality is essential to reap the benefit of financial development in Africa. It is thus vital for African countries to engage in drafting various programs and strategies to improve institutional quality so as to improve growth.

Keywords

• Financial development
• economic growth
• Africa
• institutional quality

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