Spillover of Financial Development and Economic Growth: Does Institutions Matter?

Abstract

The discipline of International Political Economy (IPE) aspires to provide insight into its complex surroundings and their intertwined interactions across various levels of nations, markets, and international entities. In the contemporary world, the modern economic system is mostly the result of economic liberalism, which promotes the state's limited role in its interaction with the market. Because of the shortcomings and side effects of the free-market system, institutionalism has gained traction. It advocates for robust property rights, low transaction costs, and appropriate contract enforcement. The majority of research on institutions and the finance-growth link in neoclassical settings is contradictory and ambiguous. This study explores the institutional spillover on financial development and economic growth through different levels of structures. The variables of good governance indicators for institutions and financial development index to measure financial development and per capita GDP for economic growth are mainly used in this study. In order to investigate the geographical spillover of the institutions on the finance-growth nexus, the first aim is investigated by employing spatial econometric modeling to analyze panel data of 152 countries for the years 2002–2019. The findings suggest that the financial growth and institutions of neighboring nations have an opposite geographical spillover effect on the home country. The second aim is achieved by employing global panel data from 181 countries for the years 2002–2018 using simultaneous equation modeling. The financial market and its moderation of economic growth indicate a spillover behavior. The third aim is explored by the analysis in the Sri Lankan context using the data from 1990–2019 by time-series modeling and provincial data from 2013–2019 for nine provinces using spatial econometrics, including inclusive growth to compare the institutional impact on economic growth. Results find that the mediator impact of institutions on inclusive growth and moderation impact of institutions with financial development on economic growth is adverse. Furthermore, fiscal decentralization did not significantly affect inclusive development or economic growth, according to provincial studies. The findings indicated that international monitoring and governance systems have not succeeded regarding individual nations and that global governance is a positive sum game. Local institutions might be revitalized by strong governance and connections to the global governance framework, hence preventing institutional collapse at the state level.