FINANCIAL DEEPENING AND ECONOMIC GROWTH IN NIGERIA

Introduction

Background to the Study

It is no doubt that the robustness of a nation’s financial system brings to mind the strength of the nation’s economy and on the contrary, the strength of a nation’s economy can be the reason for the nation’s robust financial sector. Financial systems all over the world play fundamental roles in the growth and development of the economy (Ofanson, Aigbohaebolo and Enabulu 2010). The effectiveness and efficiency in performing these roles, particularly the intermediation between the surplus and deficit units of the economy depends largely on the level of development of the financial system.

Long-term sustainable economic growth depends on the ability to raise the rate of accumulation of physical and human capital (Adelakun, 2011), to use the resulting productive assets more efficiently and to ensure the access of the whole population to these assets (Birdsall and Londono, 1997). The importance of an efficient financial sector lies in the fact that, it ensures domestic resource mobilization, generation of savings and investments in the productive sector. Financial intermediation supports this investment process by mobilizing household and foreign savings for investments by firms;

ensuring that these funds are allocated to the most productive uses; spreading risk and providing liquidity so that firms can operate efficiently.

Financial deepening/development thus involve the establishment and expansion of institutions, instruments and markets that support this investment and growth process. Historically, the role of banks and non-bank financial intermediaries ranging from pension funds to stock markets has been to translate household savings into enterprise investment, monitor investment, and allocate funds as well as to spread risk. Financial deepening/development start with the banking system and depend on the diffusion of scriptural money which the banking system provides.
The debate on the depth of the financial sector and economic growth has been on-going for the past two decades. There are basically two schools of thought.

The first one asserts that, financial deepening/development plays limited role in accompanying the development of real activity (Robinson, 1952; Lucas 1988). This school considers that, when the economy develops, the financial system develops. Robinson (1952), asserts that “where enterprises lead, finance follows” and according to Lucas (1988), economists “badly over-stress” the role of financial factors in economic growth. Rajan and Zingales (1998) and Cameron (1967) opined that, although financial deepening/ development is essential for growth, it is only “a lubricant but

not a substitute for the machine”. That is, financial deepening is only an enhancer but not a stimulant. The second school of thought on the other hand, accords a crucial role to financial deepening in boosting the processes of growth, innovations and economic growth and development (Bagehot, 1973; Schumpeter, 1911; McKinnon 1973 and Levine 1996). These authors are of the opinion that causality proceeds from financial development to economic development. According to the McKinnon-Shaw hypothesis (1973), the conventional wisdom is that, flexibility and efficiency of the financial systems are crucial to the growth and development of market economy.

Haber, North and Weingast (2008) assert that “countries do not have large banking systems and securities markets because they are wealthy; they are wealthy because they have large banking systems and robust securities markets”. Similarly king and Levine (1993) argue that, finance does not merely follow in the wake of economic activity. They affirm that, the significant robust relationship between the degree of financial deepening and the rate of economic growth indicates much more a positive association between contemporaneous shocks and financial/economic growth. For Levine (1996), there is even evidence according to which the level of financial deepening/development is a good predictor of future rates of growth of capital accumulation and of technological change.

In Nigeria, there has been an underdevelopment of the real sector and it has been envisaged that, the reason for this is the lack of funds from the financial sector to this sector. This ought not to be so because over long periods, there has been in most countries a rough but unmistakable parallel between economic growth and financial deepening / development.

Statement of the Problem

While there is a near consensus that a well-functioning financial sector is a precondition for the efficient allocation of resources and the exploitation of an economy’s growth potential, the economic literature is less consensual on how and to what extent finance affects economic growth. This, invariably, culminated in the emergence of demand-led theory of finance-growth nexus. Among others, Robinson (1952) argues that where enterprise leads, finance simply follows, suggesting that it is economic development which creates the demand for financial services and not the vice versa. Giving further support to this line of argument, Gurley and Shaw (1955) contend that, if income grows at a warranted pace, then the demand for financial assets also grows at a specifiable pace. Moreover, Lucas (1988) has argued that economists “badly overstress” the importance of the financial system on economic growth. It is simply a “sideshow” for economic activity. Recent development in some economies around the world seems to provide further support for this school of thought. Specifically, the rapid growth of many Asian economies was accomplished despite a domestic financial sector that

could not be regarded as developed (Sham, et al. 2001). This observation also holds for China (Lardy, 1998). With an average real GDP growth of 13.5 percent between 2005 and 2007, China’s economic performance is extremely difficult to reconcile with the widespread view that its repressive financial system (in the McKinnon-Shaw sense) grossly distorts the optimal allocation of loanable funds and is therefore inefficient.

In view of this puzzle, this study carried out an empirical analysis at country level to examine whether it is the development/deepening of the financial sector that leads to economic growth or it is economic growth that leads to financial deepening/development in Nigeria.

Research Questions

The following research questions are examined in this study:

1. What is the direction of causality between financial deepening and economic growth?
2. To what extent is the impact of the causal relationship between financial deepening and economic growth?

Objectives of the Study

The broad objective of this study is to empirically investigate the nature of the relationship between financial deepening/development and economic growth in Nigeria. Specifically, this study intends to:

1. Investigate the direction of causality between financial deepening and economic growth in Nigeria.
2. Examine the extent of the impact of the causal relationship between financial deepening and economic growth in Nigeria.

Research Hypotheses

The research hypotheses to be tested in this study are stated in the null form as shown below:

Hypothesis I

HIo: Financial deepening does not granger cause economic growth or economic growth does not granger cause financial deepening.

Hypothesis II

HIIo: There is no significant casual relationship between financial deepening and economic growth.
Significance of the Study

Financial system is seen as a vehicle for promoting economic growth. Financial institutions identify the most efficient investment ventures and channel resources from savers to investors. It also screens borrowers, manages risks and operates the payment and settlement system. Thus, development of an efficient and vibrant financial system is fundamental to macroeconomic stability. Existing literature has only discussed this relationship in theory. This study is significant and unique because, it empirically investigate the causal relationship between financial deepening and economic growth, thereby filling the existing gap in the literature.

More so, this study will contribute to the existing literature by extending the study period to 2012 and employ more sophistical and higher techniques of estimation in order to achieve reliable and consistent result. Ultimately, the findings of this study will serve as a policy guide to the government and captains of industries.
The study will also serve as a reference material for further studies on finance-growth nexus and other academic works.

Scope of the Study

This study shall focus on the empirical relationship that exists between financial deepening/development and economic growth with particular reference to the Nigerian state. The empirical investigations is however be restricted to the period between 1981-2011 to ascertain whether causality proceeds from financial deepening to economic growth or vice versa. The study also examined the degree or magnitude of the causal relationship between financial deepening and economic growth in Nigeria.

Research Plan

This study is made up of five chapters. The first chapter covered the introduction, statement of the problem, research questions and objectives of the study. It also included research questions, objectives of the study, research hypothesis, significance of the study, scope of the study and the research plan.

Chapter two presented related literature concerning financial deepening and economic growth. Conceptual issues, theoretical framework and empirical review of literature are all contents of this chapter.

Chapter three focused on the research methodology which includes the research design, sources and kinds of data, data collection and the estimation techniques.

This chapter dealt with the explanation of the variables of the model. The fourth chapter focused on data presentation and analysis while conclusion, summary and recommendations are contents of chapter five.