The growth effect of international financial integration evidence from cross country analysis

UNIVERSITY OF ECONOMICS
HO CHI MINH CITY
VIETNAM

ERAMUS UNIVERSITY ROTTERDAM
INSTITUTE OF SOCIAL STUDIES
THE NETHERLANDS

VIETNAM - NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE GROWTH EFFECT OF INTERNATIONAL
FINANCIAL INTEGRATION: EVIDENCE FROM
CROSS COUNTRY ANALYSIS

BY

HO THY DUNG
Academic Supervisors:
Dr. DUONG NHU HUNG

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, December 2016


UNIVERSITY OF ECONOMICS
HO CHI MINH CITY
VIETNAM

ERAMUS UNIVERSITY ROTTERDAM

INSTITUTE OF SOCIAL STUDIES
THE NETHERLANDS

VIETNAM - NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE GROWTH EFFECT OF INTERNATIONAL
FINANCIAL INTEGRATION: EVIDENCE FROM
CROSS COUNTRY ANALYSIS

By

HO THY DUNG

Academic Supervisors:
Dr. DUONG NHU HUNG

HO CHI MINH CITY, December 2016


CERTIFICATION
“I certify that the substance of this thesis has not already been submitted for any
degree and have not been currently submitted for any other degree.
I certify that to the best of my knowledge and help received in preparing this thesis
and all sources used have been acknowledged in this thesis.”

HO THY DUNG


ACKNOWLEDGMENTS

First of all, I would like to express my heartfelt gratitude to Doctor Duong
Nhu Hung, my supervisor. His inspiration together with supports has encouraged
me to complete this thesis.
I also take this chance to convey my sincere thanks to Doctor Truong Dang
Thuy. I am so appreciate to his help and enthusiasm.
Finally, I am deeply grateful to my family, friends, Ms. Tang Thi Xuan
Hong (Programme Secretary) and my colleagues for their help and sharing of their
resources to complete this thesis successfully and in time. Thanks so much for
everything!


ABSTRACT
Currently, international financial integration (IFI) is a trend of the world.
However, there is little evidence of its positive impact on the economic growth.
The reasons can be error in measurement of IFI indicators, the multicollinearity
among variables in model (Quinn and Toyoda, 2008). They may lead to the
inconsistent results and accounts in part for larger standard errors and biased
estimator. Different data might also contribute to these inconsistent results. The
targets of this paper is to study the role of IFI on economic growth with impact of
macroeconomic instability using FDI and portfolio investment capital with 2
weighted ways to proxy for IFI. With the latest annual data in the period of 19822014, the paper employs GMM method for estimating the panel-data. We start by
employing VIF indicators and normal distribution assumption to choose
conditional variables, dropping outliers and collinearity. We also provide a global
picture about the economic performance of countries in the world.
In empirical analysis, my research finds a robust and positive statistically
significant association between flow of FDI and the real GDP per capita growth.
The finding emphasizes the important role of IFI in enhancing economic growth.
We also find a weak evidence that macroeconomic instability has negative effect
on the impact of IFI on economic growth. Interestingly, my thesis asserts the
existence of inverse linkage between money supply and economic growth. This

finding is sharply contrasts with conventional wisdom of many people who think
that financial deepening will benefit for economic growth.


ABBREVIATIONS
i.

IFI

International financial integration

ii.

FDI

Foreign Direct Investment

iii.

FE

Fixed Effect Model

iv.

RE

Random effect model

v.

GMM

Generalized moment of method

vi.

VIF

Variance inflation factor

vii.

OLS

Ordinary least squares


TABLE OF CONTENTS
CHAPTER 1 ....................................................................................................................................... 1
INTRODUCTION................................................................................................................................ 1
1.1 PROBLEM STATEMENT ..................................................................................................................................... 1
1.2 Research objectives ......................................................................................................................................... 2
1.3 Research questions .......................................................................................................................................... 2
1.4 Research Methodology .................................................................................................................................... 2
1.5 Organization of the study................................................................................................................................. 3

CHAPTER 2 ....................................................................................................................................... 4
LITERATURE REVIEW ........................................................................................................................ 4
2.1 International financial integration ................................................................................................................... 4

2.2 Theoretical Background underlying IFI and economic growth .......................................................................... 4
2.2.1 Classical Theory ................................................................................................................................................5
2.2.2 Exogenous Growth Theory...............................................................................................................................5
2.2.3 Endogenous Growth Theory ............................................................................................................................6
2.2.3.1 Learning by doing model ..........................................................................................................................6
2.2.3.2 Research and development model ..........................................................................................................6
2.3 Theoretical Background relate to relationship between IFI and growth ........................................................... 7
2.3.1 Overview of relationship between IFI and growth ..........................................................................................7
2.3.2 Empirical framework ......................................................................................................................................11
2.4 Conceptual framework................................................................................................................................... 16

CHAPTER 3 ..................................................................................................................................... 18
RESEARCH METHODOLOGY ........................................................................................................... 18
3.1 Determinants of international financial integration ....................................................................................... 18
3.1.1 De jure measures ...........................................................................................................................................18
3.1.2 De factor measures ........................................................................................................................................19
3.2 Data source .................................................................................................................................................... 20
3.2.1 Measures of international financial integration ............................................................................................20
3.2.2 Data for variables in model ............................................................................................................................20
3.3 Model Specification ....................................................................................................................................... 21
3.3.1 Model .............................................................................................................................................................21
3.3.2 Variables specification: ..................................................................................................................................22
3.3.2.1 The real GDP per capita growth ..................................................................................................................23
3.3.2.2 The international financial integration .......................................................................................................23
3.4 Methodology ................................................................................................................................................. 26


CHAPTER 4 ..................................................................................................................................... 28
EMPIRICAL RESULTS ....................................................................................................................... 28
4.1. Overview of real GDP per capita growth in The World .................................................................................. 28

4.2 Preliminary statistics ...................................................................................................................................... 29
4.2.1 Descriptive statistics ......................................................................................................................................29
4.2.2 Correlation of coefficients .............................................................................................................................31
4.3 Empirical result for panel data ....................................................................................................................... 32

CHAPTER 5 ..................................................................................................................................... 37
CONCLUSION AND POLICY RECOMMENDATIONS .......................................................................... 37
5.1. Conclusion .................................................................................................................................................... 37
5.2. Policy Implications ........................................................................................................................................ 37
5.3. Limitation and further research .................................................................................................................... 38

REFERENCE .................................................................................................................................... 39
APPENDIX:...................................................................................................................................... 41
List of 48 countries in research ............................................................................................................................ 41
Regression Result from Panel Data ...................................................................................................................... 41
Result with IFI1 and all control variables ................................................................................................................41
Result with IFI1, adding and subtracting variables .................................................................................................42
Result with IFI2 and all control variables ................................................................................................................44
Result with IFI2, adding and subtracting variables .................................................................................................44
Fisher test for independent variables .................................................................................................................. 47


LIST OF TABLES
Table 2.1: Effect of IFI on growth in 11 aspects………………………………………….8
Table 2.2: Summary of the empirical papers relate to relationship between IFI and growth
……………………………………………………………………………………….15
Table 3.1: Data for international financial integration …………………………………..20
Table 3.2: Summary of variables in the model ……………………………………........ 25
Table 4.1 and 4.2: Descriptive statistics…………………………………………...…….30
Table 4.3: Correlation matrix…………………………………………………………….31

Table 4.4: Fisher test with lag (1)……………………………………………………… 33
Table 4.5: Panel regression………………………………………………………………34

LIST OF FIGURES
Figure 2.1: The relationship between international financial integration and economic
growth………………………………………………………………………………..17
Figure 4.1: Trend of real GDP per capita growth in the World from 1982 to 2014….… 28


Chapter 1
INTRODUCTION
1.1 PROBLEM STATEMENT
Capital have played an important role in the economic theory. Adam Smith and
David Ricardo have perspectives that stress on the important of capital accumulation,
social capital, free trade, etc. in which the economy is self-regulating and always at
full-employment (Letiche, 1960). Exogenous growth theory of Slow and Swan stated
that capital accumulation is one of input factors of the economy growth in long run
(Solow, 1956, Swan, 1956). Arrow (1962) pointed out that specialization would affect
the comparative advantage of a country. And flow of capital or new investment as a

source stimulate the learning by doing process. Hence, both physical and human
capital will increase economic growth. In Cobb-Douglas function, we see that capital
is also main input of the economic growth (Hall and Jones, 1996).
Since the late 1980s, the world has witnessed a trend towards the deepening
integration of the domestic financial markets. There are many research on growth
benefit of international financial integration (IFI) but they cannot provide strong
evidence on this subject. Then researchers tend to find out the threshold effects in the
process of IFI. According to their view, financial globalization will have better impacts
with a certain level of some threshold conditions (Kose et al., 2006). However,
majority of them show a mixed effects or no robust result while only a number of

papers find a positive benefit of financial globalization (Kose et al., 2006, Kose et al.,
2010).
Recently, it is important to understand the impacts of IFI on growth when the
trend of opening financial market generally continued over the world. IFI not only lead
to large benefits but can also come with crises and contagion (Schmukler, 2004).
Many critics argued that IFIs’ benefits were intangible and undocumented after the
Asian crisis of 1997–98 (Obstfeld, 2009). So where is the real result of the financial
integration process that many countries are pursuing? In addition, are there certain
conditions for the better impacts of IFI on growth? Although there are many debates,
empirical research on this issue have just exploded in recent time and along many
channels.
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For these reasons, I would like to present some new evidences on the impacts of
IFI on economic growth. Whether international financial integration could be a reason
for an increasing in economic growth or not? This study concerned about the
differences in economic growth across countries in the world from 1982-2014 and
possible factors that affect economic growth. We use a large data set, which includes
more countries and additional years. In particular, I look at capital flow as channel
through which international financial integration affect economic growth.
1.2 Research objectives
My main research objectives are listed below:
 Examine whether IFI has taken part in increasing economic growth in the world.
 Examine whether the growth effect of IFI is influenced by macroeconomic
instability and financial deepening.
 To suggest policies to speed up economics growth associated with IFI process of
countries in the world.

1.3 Research questions
In order to achieve these objectives, my thesis is in an effort to find out answers
for the two following research questions:
a. Does IFI have a positive impact on economics growth at country level?
b. Does the growth effect of IFI vary under different development
characteristics of countries?
1.4 Research Methodology
My research intended to use quantitative method with panel data of 48 countries
from 1982 to 2014. The use of panel data has many advantages such as we could
control for unobserved heterogeneity and to rule out the bias of omitted variable.
I use VIF indicators and normal distribution assumption to choose conditional
variables and dropping outliers. Because of the possibility of endogeneity between IFI
variables and real GDP per capita, real GDP per capita and lag of it. I will use GMM
command in Stata. We run regression for each period of three years because it helps to
support result influenced by the short-term impact.
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1.5 Organization of the study
My paper consists of four main parts. The first part is introduction chapter.
Chapter 2 is the theoretical framework to make sure that my research is built on a truly
of scientific knowledge. It widely discuss about definition of IFI, present theoretical
insights as well as empirical works of previous scholars. It also present the regression
results from panel data using GMM command. Chapter 3 is the research methodology.
In this chapter, I will set up models to find out the impact of IFI on economics growth
with conditional factors. Chapter 4 draws conclusion of this research and chapter 5
recommend policies in order to help policy makers have better policies with IFI
process.

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Chapter 2
LITERATURE REVIEW
I begin this chapter by discussing Aspects of IFI. Next, the theoretical
background about relation of economic growth and international financial integration
along is presented. Finally, we have an overview of empirical works about this issue
and their results.
2.1 International financial integration
The concept of market integration is central to research in international finance,
international economics and development economics. Before defining international
financial integration, we look at financial integration. Emanuelsson et al. (2012)
generalized that we have direct financial integration when the risk-adjusted returns are
the same between financial markets. We have indirect financial integration when the
return of investments between different markets are linked indirectly. And we have
total financial integration when direct and indirect financial integration are coexist.
Moreover, we also have concept of perfect total financial integration and segmentation.
In this case, the markets will have one real interest rate or opposite circumstance,
respectively. The level of integration is influenced by transaction cost between markets.
Based on empirical studies, the researchers used many ways to define financial
integration. The most common approach focuses on geographical integration. This is
also the way that our paper research the financial integration. It mention international
financial integration or financial integration across countries and their economic
growth.
2.2 Theoretical Background underlying IFI and economic growth
IFI means the way capital flows move across countries, which results a direct

change of domestic Savings, technological, management and domestic financial sector
development. Beside of that IFI also promote for specialization, better economic
policies and signaling (Prasad et al., 2003). Hence, discussion about theories that
relates to IFI and growth is very useful. It helps us a clearer understanding about
growth as well as the simplest way IFI affect to growth. In other way, economic

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growth came from stock of factors of production or efficiency of those factors. This
laid the basis for model of the research.
2.2.1 Classical Theory
It is represented by Adam Smith and David Ricardo. Smith stated that the
economy is influenced by an invisible hand with the objective economic rules.
However, it need conditions including commodity production and commodity
exchange. He also thought that the accumulation of capital and the efficiency of labor
are two main factors lead to the economic growth. Capital accumulation will enhance
the expansion of the market and the specialization of labor. With high level of
specialization, the wage rise that lead to the increase in the demand and the expansion
of the market.
And David Ricardo modified it by including diminishing returns to land. The
technological changes are highly assessed for impacts on the economic growth (Lanza,
2012).
In general, the theory determines three factors having the effects on the
economic growth are capital, labor and technology. Which are severed direct effects of
IFI. IFI will lead to an increase in capital accumulation via domestic saving because
the decrease in capital returns. And FDI inflows rise during IFI process has generated
technology spillovers and better management (Prasad et al., 2003)

2.2.2 Exogenous Growth Theory
Exogenous growth theory is also known as “neoclassical growth theory”. The
model contributed to economic growth literature in the long run by exploring factors
including capital accumulation, the growth of population and productivity (Solow,
1956, Swan, 1956)
One sector neo-classical growth model stated that technical is constant and
capital and labor inputs determined output. We have model as follow:
Y (t) = F (K (t), L (t))
With Y is real output, K is capital stock, L is labor force and t is time

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This model suggests that IFI will lead to allocation of capital, specialization
and sharing of risk. Then it lead to the increase in productivity and growth (Kose et al.,
2006)
2.2.3 Endogenous Growth Theory
2.2.3.1 Learning by doing model
Learning by doing concept mentions emphasize repetition task and practice of
worker. It will help workers to increase their ability.
This model also concentrate on comparative advantage and growth that are
involved to trade. A country can get comparative advantage and growth by specialize
in producing goods with higher potential for learning. Trade affect specialization of a
country and rely on the level of learning externalities.
Learning by doing was introduced by Arrow in 1962. He state that new
knowledge can be produced through the learning by doing process is diminishing. And
we need new flows of capital to stimulate this process (Arrow, 1962). This can be seen
more clearly in the production function of Cobb – Douglas as follow:

Y  BK  L1
Where Y is the output of economy, L is the labor force, K is the capital which is
included both physical and human capital. B is the level of knowledge increase from
learning by doing process.
2.2.3.2 Research and development model
Research and development model was introduced firstly by (Romer, 1986). He
argued that knowledge is an input in long run growth model. In this model, growth rate
can be increasing over time because increasing marginal productivity of knowledge.
Jones (1995) summarized R & D model in the following equation:
Y K

1

( ALY )



Where Y is output, K is capital, A is stock of knowledge or productivity, which is
already exist in the economy, L is labor. We can simply understand A as stock of
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knowledge that were accumulated in the past by researchers. Labor can be used to
produce output or create new knowledge.
Base on this equation, an increase in stock of knowledge would experience an
increase in economy input. And countries invest more in R&D also has higher
economic growth.

In general, Endogenous Growth Theory revolves around the elements capital,
labor and technology and productivity. Hence, we can expect a signal relationship
between IFI and Growth when we compare with result of IFI process in economy.
Besides the theory basis above, (Kose et al., 2006) point out that output volatility
of IFI not explicit in theory. Simultaneously with risk diversification, IFI can be
affected by certain features that make countries more vulnerable to external shocks.
Hence, effect of IFI also base on conditions of the economy.
2.3 Theoretical Background relate to relationship between IFI and growth
2.3.1 Overview of relationship between IFI and growth
Based on theories, countries attend IFI process not only get potential benefits
but also bear potential cost. When a country access to international financial market,
its investors have more opportunities to diversify portfolio, achieve higher riskadjusted rates of return. Domestic economy gain from international risk sharing and
abundant capital. However, the risk of volatility and flow of capital may be a
significant cost. Evidence are financial crises that comes with instability of crossborder financial markets and the risks of international financial transactions (Agénor,
2003).

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Table 2.1: Effect of IFI on growth in 11 aspects
Aspect

Reason
‘counter-cyclical’ role of world
Consumption smoothing
capital markets
complementarity effect play an
Domestic investment and growth important role

portfolio capital flows is an
important factor of economic
growth indirectly
Enhanced macroeconomic
reward and punishment
discipline
mechanism
Increase competition of banking
The efficiency of banking
system and decrease risk of
system and the stability of
depositors by foreign institutions
financial market
in periods of financial instability
Channel of Effect
process
The allocation and lack of access unbalance allocation of capital
of capital flows
flows
Domestic misallocation of
distortions and poor supervision
capital flows
of domestic financial system
Loss of macroeconomic stability flexible exchange rate
The cyclicality of short-term
capital flows
asymmetric resources
sensitive movement of short-term
volatility of capital flows
capital flows

liberal lending policies, lower
operational costs and sensitive
Participation of foreign banks
movement of foreign banks

benefit
Stabilization in temporary shocks
positively relate to economic growth

promote the improvement of
macroeconomic policy
improvement of domestic financial
markets and risk diversification of
depositors
Cost
shortage of capital in some specific
countries
Limitation in long-run growth
increase financial volatility
increasing macroeconomic instability
Financial contagion
‘too big to fail’ domestic bank and
instability of domestic banking
system
Source: (Agénor, 2003)

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We can see that benefits and costs of IFI surround capital flows. Especially,
FDI capital play a core role when portfolio investment capital have an important
position. In addition, final potential gain is higher economic growth rate but difference
between countries base on initial conditions.
Kose et al. (2006) research same issue with (Agénor, 2003) but they
summarized impacts of IFI in two views. These views are also discussed in (Prasad et
al., 2003)
Traditional view mentions on direct channels in which, capital flows will lead
to GDP growth and decrease consumption volatility.

Source: (Kose et al., 2006)
And other view focuses on the catalyst effect of IFI for certain collateral
benefits.

Source: (Kose et al., 2006)
According to Schmukler (2004), IFI tend to be positive in long-run for some
countries if they get over challenges. He focus on developing countries and state that

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with IFI process, capital flows allocate mainly in middle-income countries and not
same for different domestic sector.
Almost Researchers agree that net benefit of IFI can be positive or negative
depend on conditions of countries. And (Kose et al., 2011) generalized them into
thresholds that countries need to overcome if they want to gain from IFI.

Source: (Kose et al., 2011)

Base on existing theoretical literature, he choose thresholds including financial
market development, the overall level of development and other national index such
as trade openness and labor. They find that conditions are much lower when IFI is
proxied by stocks of FDI and portfolio equity liabilities. The thresholds are also
different with data samples. Most of developed countries and only some emerging
markets are above threshold levels while almost developing countries achieve them.
In general, the literature points out two views on the impacts of IFI on growth.
The composition hypothesis focuses on all capital flows and shows their effects on
growth. Researchers find out the role of each kind of capital flows on growth,
compare positive and negative effects. The threshold hypothesis focuses on certain
minimum conditions that each country need to meet to benefit from IFI. However,
according to (Wei, 2006), these two hypothesis can be “the two sides of the same
coin”. He found that nations have low development of financial sector attract inward
portfolio equity flows more than inward foreign direct investment.

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2.3.2 Empirical framework
Until now, many studies research the relationship between IFI and economic
growth. Most of papers do research based on a “large n” sample with various
methodologies and variables. The majority of researcher can not to find clear evidence
on the growth effect of IFI while only a number of papers can get systematic evidence
to support this point (Kose et al., 2006, Rodrik and Subramanian, 2009). In addition,
they could not find enough systematic evidence to explain the impacts of IFI on
growth based on threshold effects.

For the first time, de Jure measures were mainly use to evaluate IFI. Quinn
(1997) has set an assessment by himself. He developed coding rules based on IMFs’
AREAER to calculate changes in international financial regulation. He adopted a scale
for each dimension of goods, exchange restriction and invisibles payments and
receipts, international agreements and laws. Data include 64 countries for 1958 to
1989. Firstly, a basic model of long run growth in which the measure of change in IFI
was added to as an independent variable. Then the model was added and subtracted
variables to see the changes. He found that capital account liberalization (CAL)
robustly linked with economic growth. In 2008, Quinn and Toyoda reexamine the role
of CAL on economic growth with data of 94 nations from 1950 to 2004, using pooled
time-series, cross-sectional OLS and system GMM estimators. GMM estimators allow
for the endogeneity of CAL to growth. This study have shown robust evidence for a
positive benefit of financial liberalization to economic growth and stated that
conflicting results may derive either from measurement error or differing periods of
data (Quinn and Toyoda, 2008).
The later stages, there is a trend of using de factors measures or various
measures and methods to research this relation because the availability of data and the
extent of the growing international financial integration increasing ability to reflect IFI
of de factors measures .
De Gregorio Rebeco (1999) emphasize the role of financial development in
finding the effect of IFI on growth. Although the results are weak, he found a positive
relation between IFI and the development of domestic financial system. However, no
evidence of effect of IFI on growth. Author also found portfolio diversification and
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welfare effects might allow a greater degree of consumption smoothing. It explain
portfolio diversification effect is small compare with theories.

Edison et al. (2002) is a pioneer in using mixed measures, n-large data and
various methods to research the impact of IFI on economic growth and to evaluate
whether the growth effect of IFI depends on the development of the domestic
economy. The paper exams 57 countries over the 1980–2000 or 1976-2000 period.
Statistical methodologies include simple ordinary least squares (OLS) regressions,
two-stage least squares instrumental variable estimator and dynamic panel procedure
(generalized method of moments (GMM)). The dynamic panel approach help author
to control for country specific effects, which may bias the coefficient estimators. In
order to reduce the cyclicality of the data, five-year averages were chosen to run
model. Assortment of measures and methodologies can contribute to the robustness of
result. The reasons can be international differences in barriers to financial transactions
and measures cannot fully distinguish them. He found no robust evidences on the
growth benefit of IFI even when controlling for particular conditions. However, the
research can be referenced because the generalizability of the study.
Similarly to (Edison et al., 2002), Vo (2005) also use many measures and
methodologies to research this topic but bigger data sample (79 countries), broader
and more detail measures covering the period from 1980 to 2003. In particular aspects,
the result is quite same with (Edison et al., 2002) when it point out the relationship
between IFI and economic growth not depending on different economic conditions.
However, he found out evidences indicating a weak relationship between IFI and
growth. It is consistent with the current literature.
Because advantages of panel data and dynamic panel approach, almost of later
research use GMM model and find a breakthrough from the different sample data, the
measurement of the IFI or the conditions of the economy in the study sample.
Masten et al. (2008) using macro and industry-level data in Europe with panel
estimation to analyze the effect of financial development and IFI on economic growth.
He found that countries with higher levels of financial development get more benefits
of IFI than less developed European countries.

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Lucey and Zhang (2011) using a sample of 4477 public firms from 24 countries
and investigate positive benefit negative benefit of corporate leverage to credit market
integration and equity market integration respectively. And Gamra (2009) used a
measure set by himself based on another research of (Kaminsky and Schmukler, 2002).
He concluded, “Full liberalization of the financial sector has been associated with
slower growth outcomes while more moderate partial liberalization is associated with
more positive outcomes”.
Chen and Quang (2014) provided new evidence relying dynamic panel
techniques. With the panel threshold regression, he found some evidences that
domestic financial development and moderate government spending will support
potential gains from IFI.
Schularick and Steger (2010) run regression covering 24 countries for the years
1880-1914 using both cross-section regression and GMM panel estimation. The result
show that in the first era of financial globalization, IFI boosted economic growth but
no robust relation today. Because employing similar models and techniques with
former researcher, author stated that not the model or regression method but data that
drive the findings.
Focusing on country specific effect, several researchers point out that countries
that have higher level of wealth and education tend to have higher level of integration.
Researchers consider IFI with a set of threshold conditions. Empirical studies on the
benefit of IFI on economic growth has used the growth rate of real per capita GDP
growth as measure of economic growth, measures of IFI plus control variables which
proxy growth drivers with dynamic panel model (Schularick and Steger, 2010). Kose
et al. (2011) stated that there are levels of country characteristics such as domestic
financial market development, institutional quality, labor market rigidities, trade
openness, general development that are important determinants of growth benefit of

IFI.
Broto et al. (2011) state that global factors get important role link to country
specific drivers. Wyplosz (2001) found that developing countries have lower level of
financial liberalization than developed countries. Furthermore, financial liberalization
of also contributed to crises in emerging countries (Aizenman, 2004).
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Another trend of Inherit to former theoretical framework and research
methodology of the IFI, a large number of the researchers in the last few centuries
focused explore the impact of the IFI to the developing countries (DCs). Although
theoretical basic of growth benefit of IFI in Developing countries is strong, there is
little evidence about this issue. IFI can offer a major boost to growth or cause an
exodus of domestic capital if preconditions is sufficiently weak (Prasad et al., 2003).
Majority of researchers using a “large n” sample including to evaluate the impact of
IFI on growth. They usually do research in general on these two groups after control
for some initial conditions (Quinn, 1997, Masten et al., 2008). The papers that focus
on DCs countries are still little and not systematic. They focus on different sector
through which IFI affect economic growth such as business cycle, domestic
development, stock market, CAL. Özbilgin (2010) stated that financial integration are
associated with higher investment and output volatility.
Table 2.2 generalize empirical papers that have presented in this section. It can
help us have an overview about research of relationship between IFI and economic
growth.

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Table 2.2: Summary of the empirical papers relate to relationship between IFI and
growth
Authors
Quinn (1997)

Time Period
1960 to 1989

Observations
64 countries

Method
OLS

Quinn and
Toyoda (2008)

1955 to 2004

94 countries

de Gregorio
Rebeco (1999)

1976 to 1993

24 countries

pooled timeseries, OLS,
fixed effect
regression
and GMM
OLS

Edison et al.
(2002)

1980–2000 or
1976-2000

57 countries

OLS , 2SLQ
and GMM

Vo (2005)

1980 to 2003

79 countries

Masten et al.
(2008)

1996 to 2004

31 European
countries

OLS, Panel
Estimator,
2SLQ,
GMM
GMM

Gamra (2009)

1980–2002

6 emerging
East Asian
countries

LS, 2SLQ,
panel fixed
effect,
GMM

Chen and
Quang (2014)

1984–2007

80 countries

Panel
Estimator,
GMM

Schularick and
Steger (2010)

1880-1914

24 countries

OLS and
GMM

Kose et al.
(2011)

1975–2004

84 countries

OLS, panel
fix effect
and GMM

Ho Thy Dung / MDE K21

Findings
Capital account liberalization
(CAL) robustly associated
with economic growth
A positive relation between
financial liberalization and

economic growth

Weak positive link from
financial integration to the
development of domestic
financial system but no
evidence of effect of IFI on
growth
No robust evidences on the
growth benefit of IFI even
A weak relationship between
IFI and growth

Countries which have higher
levels of financial
development get more
benefits of IFI than less
developed European
countries
Moderate partial
liberalization will get more
positive outcomes than full
liberalization
Domestic financial
development and moderate
government spending will
support potential gains from
IFI
In the first period, IFI
boosted economic growth but

no robust relation today
Some country characteristics
are important determinants of
growth benefit of IFI

15


To sum up, classical theory, exogenous growth theory and endogenous growth
theory strongly support the role of stock and efficiency of capital factor on economic
growth. According to these theories, capital lead to resource allocation, technology
transfer, innovation and specialization that contribute to economic growth. And
empirical studies research the relationship between IFI and economic growth based on
these literature. They function economic growth with IFI is an independent variable
because IFI process will affect stock and efficiency of capital factor.
Based on literature review, I lead to hypothesis as follow:
H1: IFI has a positive link to economic growth
H2: In country with low inflation rate, the growth effect of IFI tend to be higher.
Based on above arguments. I try to avoid the possibility that lead to conflict
results of empirical studies that are measurement error, different data, the clustering
and collinearity. With annual data in the period of 1982-2014, we have the latest data.
I employ VIF indicators and normal distribution assumption to choose conditional
variables, dropping outliers and collinearity. Moreover, I also use GMM regression
that is the best method in the present.
2.4 Conceptual framework
In this section, I determine the framework of my research as well as variables
that including in my model. After handling econometric errors, I examine the effects
of IFI on the economic growth through two channels. The first is traditional channel
that capital flows will lead to GDP growth. The second is indirect channel. And in this
channel, capital flows affect the economic growth in the presence of different

development characteristics of countries. They include macroeconomic instability and
financial deepening. For more details of variables, I will specify in model
specification section.

Ho Thy Dung / MDE K21

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