Financial Flows, Composition of Capital, and Growth

Abstract

This paper investigates the extent to which financial integration promotes growth by improving the quality of a country's capital stock. To that end, it derives a capital composition index, where the share of a particular type of capital in the total capital stock is determined by its embodied efficiency. The paper constructs its empirical counterpart using capital production and trade data. Using five-year averaged data between 1976 and 2001 for 60 countries, it provides evidence on the positive effects of financial flows on the capital stock's quality, with the largest impact coming from equity inflows. It also shows that when the capital composition is accounted for, the direct effect of financial flows on TFP diminishes. Although financial flows do not directly affect growth, they raise it indirectly by improving the composition of a country's capital stock. All else constant, financial flows explain a growth difference of 1.10 percentage points between the countries with total liabilities equal to the first quartile and the third quartile. Finally, the paper finds that the effect of financial flows on the composition of capital and therefore GDP growth is larger for less developed countries, and smaller and insignificant for countries with less developed financial markets. [JEL E22, F15, F21, F43, G15] IMF Economic Review (2015) 63, 325-352.

Financial Intermediation, Capital Composition and Income Stagnation: The Case of Europe

“…By looking at 10 new EU members for the period 1994period -2007period , Caporale et al (2015 show that productive capital accumulation is the best determinant for growth implying that it is mandatory for the financial system to provide support to firms since they are the drivers for capital accumulation. The growth enhancing route between finance, productive capital and GDP growth is also found by Leblebicioğlu and Madariaga (2015) who provide evidence of financial flows and financial development on GDP growth through the composition of capital. Interestingly enough, irrespective of the importance of allocating finance to capital accumulation, the financial institutions seem to move in the opposite direction: approximately two thirds of the typical banks' business consist of household lending for real estate purposes to the point that "housing finance has come to play a central role in the modern macro economy" (Jordà et al, 2016).…”

FDI and Financial Market Development in Africa

“…For example, using a system of simultaneous equations, Klein and Olivei () focus on how capital account liberalisation impacts growth and find that financial liberalisation positively affects financial depth, and therefore economic growth. Similarly, Leblebicioglu and Madariaga () examine how financial inflows improve the composition of capital and contribute to growth and find that FDI and equity inflows have positive and significant effects on the composition of capital. In a further analysis, the authors show that financial development (measured by private credit to GDP ratio) is positively related to capital composition.…”

“…Although it is established that FDI contributes more to growth in countries with more developed financial market (e.g. Alfaro et al, 2004Alfaro et al, , 2010Klein and Olivei, 2008;Leblebicioglu and Madariaga, 2012), it is not clear how FDI and FMD interact with each other, especially in Africa, where financial markets are still at a developmental stage.…”

Financial intermediation, capital composition and income stagnation: The case of Europe

“…By looking at 10 new EU members for the period 1994-2007, Caporale et al (2015) show that productive capital accumulation is the best determinant for growth implying that it is mandatory for the financial system to provide support to firms since they are the drivers for capital accumulation. The growth enhancing route between finance, productive capital and GDP growth is also found by Leblebicioğlu and Madariaga (2015) who provide evidence of financial flows and financial development on GDP growth through the composition of capital. Interestingly enough, irrespective of the importance of allocating finance to capital accumulation, the financial institutions seem to move in the opposite direction: approximately two thirds of the typical banks' business consist of household lending for real estate purposes to the point that "housing finance has come to play a central role in the modern macro economy" (Jordà et al, 2016).…”

“…In addition, the "crowding-out" suggests a direct negative effect of HOUSECAP on INC2GDP, and hence an indirect negative effect of HHLEVERAGE on INC2GDP via HOUSECAP.The indirect association on INC2GDP by HOUSECAP via finance can be best formulated in a 2 stage least squares system with fixed effects (2LS-FE). Similarly toLeblebicioğlu and Madariaga (2015), we estimate simultaneous regressions in which the first stage LS regresses HOUSECAP on finance variables (HHLEVERAGE, CORPDET, NCREDIT) and in turn the second stage LS regresses INC2GDP on HOUSECAP. As such, HOUSECAP is instrumented on HHLEVERAGE, CORPDEBT and NCREDIT.…”