Financial Reforms, Financial Development, and Economic Growth in the Ivory Coast

1. Introduction

The annual growth rate of real GDP per capita is an important statistical indicator to assess the economic performance of any economy. As a result of this evidence, a large amount of theoretical and empirical studies have attempted to identify the main drivers of economic growth and potential sources of growth. These drivers differ depending on space and time. That said, the evidence of a conclusion is not reached. The debate on the issue of financial development source or effect of economic growth is still current. Another source of debate in the literature on the finance-growth nexus is the appropriate or proper measure of financial development, Adu et al. (2013) [ 1 ].

Therefore, the research team would like to highlight the several financial reforms engaged in the Ivory Coast since 2014. The purposes of these reforms are to strengthen the stability of the financial sector and to promote its development, with the final goal to sustain the recent economic growth. The key components of these reforms include the following: (1) restructuring the public banks, (2) strengthening the transparency in financial data handling, (3) deepening the financial market by diversifying the capital market; (4) preserving and increasing the professionalism of the microfinance sector, (5) increasing small and middle-sized enterprises (SMEs) access to credit and to leasing, (6) fostering credit for mortgages, (7) regulating traditional or customary land tenure, (8) organizing producer associations, (9) rationalizing access to guaranty funds and developing a strategy to finance subsistence agriculture, and (10) strengthening the supervision of insurance and broadening insurance coverage to a larger share of the population. It seems to us that these reforms support the idea that financial development would be very important for the economic growth in the Ivory Coast. Based on this assumption, the research team has conducted this study to test the relationship between financial reforms, financial development and economic growth in the Ivory Coast and identify the channels of transition.

In our study, we use techniques of time series. This is the most common approach of the finance-growth nexus in the literature. Furthermore, we have first conducted a common component analysis (CCA) on our time series data of the different financial development proxies, to create a variable that would be the most appropriate proxy for the financial development. In addition, another CCA has been conducted on the other explanatory variables of economic growth, to create a vector of control variables for the economic growth. Secondly, a vector autoregression model (VAR) with restriction was used as an appropriate specification of the dynamic relationship between the proxy of financial development, economic growth and other important factors of that growth (vector of control variables).

The first challenges were encountered early in the research, which has used a variety of Granger causality tests. Most of them support the hypothesis of finance leading to growth. Our study is based on the estimated effects between growths on a large number of indicators of financial development. We do this to solve the problem of appropriate and proper financial development measures. Existing studies have identified several transmission channels through which financial development could affect economic growth through their effects on savings and investment. According to Levine (2002) [ 2 ], if given prior information on investment opportunities, monitoring investments and the implementation of corporate governance, trade diversification and risk management, mobilization and accumulation of savings, and the exchange of goods and services; then financial development causes an improvement in production. Each of these financial functions could influence the decisions of savings and investment and thus economic growth.

Since several market frictions and regulatory laws exist, and there are remarkably different policies around the world and through time, improvements in each of the specific situations or dimensions can have different implications for resource allocation and spending for the welfare of others types of frictions involved in the economy. That said, empirical studies show that the hypothesis which states that financial development is an important driver of economic growth, is not popular in empirical research on growth.

The role of the financial market and financial intermediation in economic growth varies significantly from one country to another. It is based on the level of political freedom, protection laws, property rights, and regulations. According to Aghion and Hawitt (2009) [ 3 ], the population is willing to save more, allowing access to resources by investors in a country where there are efficient and trustworthy banks rather than in countries where there are banks that waste deposits or cause losses for investors, by granting bad credit or defrauding investors.

Markets and financial institutions help by sharing risks, as well as promoting optimal allocation of risk and return. For example, by collecting the savings of a significant number of the population and the accumulated savings by investing in a wide range of diverse projects. A Deposit Institution (DTI) also allows small savings to take advantage of the law of large numbers and to have a reasonable and safe rate of return. The proper functioning of financial institutions can also help to be an alternative to the agency problem; by monitoring investors and ensuring that they will make productive use of their loans, rather than using them fraudulently or for private consumption. There is virtually a consensus showing that financial development is good for economic growth in exogenous growth prospects and in the endogenous growth perspective. However, there is a large disagreement regarding the indicators of financial development. Besides, what is remarkable for each transmission channel is the specificity of the country, which depends on the difference in policy, legislation and other institutional differences in space and time. The above implication for a respective country yields the use of a large number of financial development indicators, increasing the potential significance of the finance-growth nexus.

This study proposes a time series approach to study the finance-growth nexus in the Ivory Coast. To do this, we first measured a common component of proxies of financial development for a reference proxy. Then, we evaluated the dynamic relationship between the common component and economic growth in the context of a VAR. Several studies of countries using time series were based on one or two indicators of financial development. A study on Ghana (Quartey and Prah, 2008 [ 4 ]) examined a causal link that bi-varied between financial development and economic growth using four alternative indicators of financial development. These indicators included the ratio of broad money to GDP, domestic credit to GDP ratio, private credit ratio on GDP, and the ratio of private credit to the domestic credit. Also, in studies of the finance-growth nexus for Ivory Coast, Keho (2005) [ 5 ] and Esso (2010) [ 6 ] use the ratio of private credit to GDP as the sole indicator of financial development.

However, we believe as other studies in the literature suggest, that a single financial indicator cannot allow us to identify the appropriate proxy for financial development for any given country. The level of financial development in a country must be considered as a composite index derived as many proxies of financial development as possible. Also, in the estimation of our model, we used each indicator one after another to control each of them. Also, we derived a composite index using each proxy information, and then as an indicator of financial development, the common components analysis (CCA) method. As in Adu et al. (2013) [ 1 ], we support that the effect of financial development on economic growth is only meaningful with choosing the appropriate proxy. In Adu et al. (2013) [ 1 ] study on Ghana, using the ratio of private credit to GDP or sector credit ratio on total private credit. They found a positive and significant effect of financial development on economic growth in Ghana. It is important to note that they are not the same result by using the ratio of the supply of broad money to GDP as a proxy for financial development and that the coefficient of this variable is significantly negative. Thus, the indexes they have created through the principal components analysis method confirm the meaning of the choice of proxy. We believe that the common components analysis is more indicated. This helps us to understand the controversial results in the literature, and therefore studies using a single indicator are not able to identify financial sector variables that produce a positive effect on the improvement of economic growth.

This research highlight that the common component has a significant long run relationship with economic growth in Ivory Coast. The findings indicate that both the deposit ratio of liabilities and the common component cause the economic growth. In other words, the causal link between economic growth and financial development is unidirectional. Furthermore, this study finding addresses the identification of the appropriate proxy for the financial development in Ivory Coast, which is the deposit ratio of liabilities. The structure of this paper is divided as follows: Section 2 presents a literature review; Section 3 describes the methods used in the study; Section 4 presents the results; and finally, Section 5 presents the discussion, conclusions, and policy implications.

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