Financial Development and Economic growth in Cote d’Ivoire: The case of a Small Economy

Financial Development and Economic growth in Cote d’Ivoire : The case of a Small Economy

Denis Joël Tongnivi FOADE - UFR-SEG, University of Abidjan-Cocody

Abstract:

The present paper analyzes theoretically and empirically the link between financial development and economic growth in the Ivorian economy. To that end, the contribution of financial development to economic growth is assessed through the broad money (M2) as percentage of GDP ratio (M2/GDP), private credit on domestic credit (CE/CI), liquid liability of out of gross domestic product (DQM/M2), indicating the banking system’s expansion in the mobilization of saving. The analysis is carried through a VAR model.

Key words: Financial development, Economic growth, Velocity of money, risk.

JEL Classification: C32, F41, F43

1. Introduction

The link between financial development and economic growth have been highlighted by the work of Bagehot (1873), Schumpeter (1912) by relying on the identification and funding of most productive investments. Later, the thesis of Robinson (1952) argued to the contrary: that financial development is a consequence of economic development. It is from this point that controversy arose over the direction of causality between growth and financial development.

Goldsmith (1969), Gupta (1984) and Spears (1992) are the first to show that financial development precedes the development referring to the economic role that the financial sector has in the economic development process. According to these authors, the primary role of a financial system is to promote and mobilize savings, main component in the formation of capital. The financial system plays fully this role when it is developed, but if it is under-
developed it does not encourage economic agents to mobilize savings. The second role is to efficiently allocate collected savings to projects whose internal rate of return is greater than the opportunity cost of money. The effectiveness of a financial system is to reduce the financial cost for borrowers and select the most profitable projects. It just comes out that, the greater the financial system will be efficient in allocating resources, the greater the productivity of capital and the stronger economic growth. The third role allocated to the financial system is the management risks through the allocation of collected savings to profitable projects
in many areas.

Some economists, such as Gurley and Shaw (1967) estimated that the causal relationship is unique and ranges from economic development to financial development. This causality is based on the finding that economic development creates needs on new financial products and services. It comes that the more income economic agents increases the more they save, and this contributes to the development of the financial sector. In a word, beyond this controversy, researches agree to recognize a fairly strong correlation between these two phenomena.

In the mid-80s, work on the relationship between economic growth and financial development have experienced resurgence in favor of financial crises and new theories of endogenous growth. The importance of financial development in economic growth was highlighted. Authors such as King, Levine (1993a) showed that the return effect of economic development on financial development is significant. Finally, one conclusion of these studies focus on the impact of financial development on economic growth. This impact can vary according to countries, periods and the level of income (De Gregorio and Guidotti 1995, Berthélemy and Varoudakis, 1994; and Levine 2007).

Empirical studies have been conducted in several developed countries on the relationship between economic growth and financial development, but they are still scarce on the African continent. Based on the finding that the impact of financial development on economic growth differs across regions, periods and income level, can we then question on this impact in regard to the Ivorian economy. Our research aims to provide the answers to this valid question not only for Cote d'Ivoire but also valid to countries Members of the Economic and Monetary Union (WAEMU).

The overall objective of this study is to analyze the link between financial development and economic growth in the context of the Ivorian economy. To achieve this overall objective, two specific objectives have emerged: (i) determine the dynamics of long term between financial development and economic growth in Côte d'Ivoire (ii) analyze the impact of financial development on economic growth in Côte d'Ivoire. The methodological approach in the context of this study will consist in the formulation of an econometric model, Vector Auto Regressive (VAR) Model highlighting the impact of financial development on economic growth of Côte d'Ivoire. The data cover the period 1962 -2008. The working method is based on documentary research, publications, reports on statistics collected by the BCEAO and IMF.

Our concerns will revolve around the following points: (2) theoretical and empirical analysis of determinants of financial development, (3) model, data and results

2 – Analysis of the determinant of the financial development

2.1 Theoretical Analysis

The effects of financial development on economic growth are both direct and indirect. Pagano (1993), has developed a model for an illustration of these channels:

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