The finance‐growth nexus enigma: Bringing in institutional context and the productiveness debate

Abstract

This paper surveys the literature on the relationship between finance and growth, from the initial simple correlation through debates on causality and channels of impact to the more recent threshold analysis. The gaps in the revisionism regarding the relationship between finance and growth are critically teased out, not least neglect of the effects of speculative finance in developing countries where a positive nexus continues to hold sway in the threshold analysis. The paper argues that the literature has focused on pursuit of a positive nexus, with inadequate attention to institutional context, which is prerequisite for enhancing a positive relationship. It has also narrowed drastically the complexity of cause and effect and ignored broader analytical approaches to the relationship between finance and growth. The classical political economy debate on finance productiveness is drawn upon, in which positive contribution is based on real output, as a critical point of departure for why greater emphasis ought to be placed on institutional context to enhance the contribution of finance to growth.

Finance – growth nexus: evidence from systemically important Islamic finance countries

“…Even though a view on the positive effect of finance on growth is dominant, a negative relationship is also found in several studies (Andersen and Tarp, 2003; Khan, 2001; Luintel and Khan, 1999). According to Itaman (2022), there is a trend in the literature that is sort of hunting for a positive relationship ignoring other determinants that may affect this nexus, particularly institutional development.…”

Analytical political economy: Complexity, growth, international trade

“…In fact, Keynes's (1936) principle of effective demand and its generalization to the long-run are present in different ways in the literatures reviewed by Blecker (2022), Demir and Razmi (2022), and Barrales-Ruiz et al (2022). On the other hand, Itaman's (2022) account of the finance growth nexus is shaped by both the Keynesian notion of money and the classical political economy debate on the productiveness of finance.…”

“…(2022). On the other hand, Itaman's (2022) account of the finance growth nexus is shaped by both the Keynesian notion of money and the classical political economy debate on the productiveness of finance.…”

“…Blecker (2022) and Demir and Razmi (2022) focus on international trade by studying, respectively, the roles that the balance of payment and the real exchange rate (RER) play in shaping long run‐growth and structural change; Barrales‐Ruiz et al. (2022) analyze the cyclical relation between functional income distribution and economic activity; and Itaman (2022) discusses the finance‐growth nexus. The four surveys fit our definition of Analytical Political Economy as they review contributions that question one or more elements of the standard supply‐side neoclassical representation of the determinants of capital accumulation and productivity growth.…”

“…Itaman (2022) develops a critical review of the literature on the relationship between finance and growth, starting from some seminal contributions focusing on the simple correlation between the size of the financial sector and countries’ growth performance, and then extending his analysis to the debate on the direction of causality and the determinants of such relation, and to the more recent threshold analysis approach, which identifies trigger points where the relation between finance and development shifts from positive to negative or vice‐versa. The paper argues that the literature has tried to identify a positive nexus between finance and growth, while neglecting the fundamental role that a virtuous institutional context plays in facilitating a positive relationship and reducing its complexity.…”