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University of Minnesota Financial Development and the Effect on Income Growth in OECD Countries: An Empirical and Theoretical Investigation Madison Whalen ECON 4331W Neha Bairoliya March 2, 2015 I. Introduction A. Intro information This paper seeks to examine the level of financial development and its effect on the growth rate in GDP per capita across the 34 OECD member countries. This theory will be examined using an Ordinary Least Squares (OLS) regression in hopes of finding results that may give some insight to countries struggling with slower growth. B. THESIS Higher levels of financial development as shown by equity market, retail banking and insurance market indicators are a contributing factor to growth in a country’s GDP per capita. C. The main results this paper seeks to prove are: Higher levels of investment in financial instruments such as loans, equities, and insurance indicate a more financially developed economy that should grow faster due to the higher savings (investment) levels. Certain types of investment, whether it be equities, retail banks, or insurance, should have a more significant effect on GDP per capita growth, and the regression will allow us to determine which factors are more influential. II. Theoretical Analysis A. Higher investment should lead to higher growth, which is much more prevalent in nations that have a stronger level of financial development. Many smaller countries do not have the resources available to provide capital in the form of loans to businesses and people, which slows down the overall growth of the country. Solow model shows higher output per capita (log(y)) when savings (s) increases as well as an increase (potentially short term) in yo/y, the growth rate of output over time. Higher investment leads to a higher money supply, creating more economic activity as it passes through the financial system. (Multiplier effect) B. Scholarly research This finding is similar to those of the empirical analysis of financial regulation and economic growth published by the OECD. (de Serres et al.) III. Survey on finance and growth (Levine) Findings in Greece (Dritsakis and Adamopoulos) Findings in India (Chakraborty) Empirical Analysis A. Hypothesis to be tested Higher levels of financial development as indicated by the data will show statistically significant high levels of correlation to higher GDP per capita growth rates. B. Model OLS Regression: 𝐺𝐷𝑃 𝑝𝑒𝑟 𝑐𝑎𝑝𝑖𝑡𝑎 𝑔𝑟𝑜𝑤𝑡ℎ𝑖 = 𝐶𝑜𝑛𝑠𝑡𝑎𝑛𝑡 + 𝛽1 𝐵𝑎𝑛𝑘𝐷𝑒𝑝𝑜𝑠𝑖𝑡𝑠𝑖 + 𝛽2 𝐹𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙𝑆𝑦𝑠𝑡𝑒𝑚𝐷𝑒𝑝𝑜𝑠𝑖𝑡𝑠𝑖 + 𝛽3 𝑆𝑡𝑜𝑐𝑘𝑀𝑎𝑟𝑘𝑒𝑡𝐶𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛𝑖 + 𝛽4 𝐼𝑛𝑠𝑢𝑟𝑎𝑛𝑐𝑒𝐶𝑜𝑚𝑝𝑎𝑛𝑦𝐴𝑠𝑠𝑒𝑡𝑠𝑖 + 𝛽5 𝑆𝑡𝑜𝑐𝑘𝑀𝑎𝑟𝑘𝑒𝑡𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟𝑖 + 𝛽6 𝐿𝑖𝑓𝑒𝐼𝑛𝑠𝑢𝑟𝑎𝑛𝑐𝑒𝑃𝑟𝑒𝑚𝑖𝑢𝑚𝑖 Data obtained from The World Bank database in percentage values for all 34 OECD countries for most variables. C. Reasoning Behind Model Bank deposits and financial system deposits – retail banking indicators Stock market capitalization and turnover rates – equity market indicators Insurance company assets and life insurance premiums – insurance market indicators D. Data Examination Regression results Data tables and plots E. Results of the test IV. Is the hypothesis verified with statistical significance? Conclusion A. Recap of results – is the hypothesis true? Restatement of thesis B. Which factors are and are not influential Retail banking Insurance Equities C. Comparison of results to other studies D. Implications of results for countries outside the OECD E. Comments Bibliography Alain de Serres, et al. (2007), "Regulation of financial systems and economic growth in OECD countries: An empirical analysis", OECD Economic Studies, Vol. 2006/2. Ross Levine, (2004), “Finance and Growth: Theory and Evidence”, National Bureau of Economic Research Working Papers Series, Vol. 10766, http://www.nber.org/papers/w10766 Nikolaos Dritsakis & Antonios Adamopoulos, (2001) "Financial development and economic growth in Greece: an empirical investigation with Granger causality analysis", International Economic Journal, Taylor & Francis Journals, vol. 18/4, pages 547-559. Indrani Chakraborty, (2010) “Financial Development and Economic Growth in India: An Analysis of the Post-reform Period “, South Asia Economic Journal, vol. 11/2, pages 287-308. The World Bank. World Development Indicators (WDI) Online. Retrieved February 28, 2015. Appendix A summary of the data used can be seen by the values in the chart below. The paper will also examine the growth and change year over year as well as the yearly level of the following six explanatory variables. 120 100 Bank Deposits to GDP % 80 Financial System Deposits to GDP % 60 Stock Market Capitalization to GDP % 40 Insurance Company Assets to GDP % Stock Market Turnover Ratio % 20 Life Insurance Premium Volume to GDP % 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 0