The Impact of Banking Sector Openness on Economic
Growth
------ A Panel Data Study
Submitted by Mao Zhiren, to the University of Exeter as a thesis for the degree of
Doctor of Philosophy in Economics, May 2009
This thesis is available for Library use on the understanding that it is copyright material
and that no quotation from the thesis may be published without proper
acknowledgement.
I certify that all material in this thesis which is not my own work has been identified and
that no material has previously been submitted and approved for the award of a degree
by this or any other University.
Zhiren Mao
Abstract
The current global financial crisis centres on the impact of banking sector openness
on economies. The tradeoff of banking sector openness between the potential benefit
(economic growth) and risk (economic volatility) sparks hot debates. This thesis
addresses the question of whether there are sufficient economic reasons to support
openness.
Banking sector openness may directly and indirectly affect growth. Chapter II
reinvestigates these direct and indirect links, using an advanced econometric
technique (GMM dynamic panel estimators). The empirical results confirm the
presence of direct and indirect links, and thus provide the backbone for countries
planning to open their banking sector to international competition, especially
developing countries.
In Chapter III, we use parametric and non-parametric stochastic frontiers to measure
banking sectors’ cost efficiencies, and then use panel data methodology to
reinvestigate the empirical relationship between bank efficiency and banking sector
openness. Our results suggest the world banking industry becomes increasingly
efficient with greater openness.
Chapter IV studies the relationship between macroeconomic volatility and banking
sector openness. We address several questions: can high levels of volatility be
explained by the opening of the banking sector? Are the effects of banking sector
openness in developing and developed countries different in a crisis compared with
normal times? What is the effect of mis-match between banking sector openness and
financial development? We find that the positive relationship between banking sector
openness and economic volatility originates from the mismatch between banking
sector openness and financial markets development. Banking sector openness in itself
eases crisis volatility.
Chapter V presents the main conclusions.
Dedication
To my mother
Acknowledgments
From the time when I decided to pursue my doctoral studies until the completion of
this thesis, I met many people who inspired me academically, professionally, and
spiritually.
I would like to express my deepest appreciation to my supervisors, Professor John
Maloney and Professor Steve McCorriston, who are my role models for being a good
scholar. Without their unwavering support, invaluable advice, and indefatigable
patience, this thesis could not have been completed. I am also grateful to have had the
opportunity to benefit form other professors’ guidance. Special thanks are due to
Professor Jonathan Temple from Bristol University and Dr. Ding Sai from Oxford
University who taught me the econometric methods. I also thank Dr. Xiaogang Bi, Mr.
Jack Rogers, and Mr. Devrim Yavuz for their valuable comments. It is my honor to
share an office with you.
I gratefully acknowledge the financial support from the Economics Department in the
form of a graduate assistantship during my graduate study. I also hope to give special
thanks to all the Exeter University Business School supporting staff for creating a
comfortable academic atmosphere for discussions and allowing students to enlighten
each other. Thanks are particularly given to Ms. Jan Adkins who has kindly offered
me any help that is needed throughout my graduate study.
Last but not least, I would like to extend my profound appreciation to my former
advisors, Professor Yulan Du, and Professor Mingliang Liu in the Institute of
Economics and Management, Nanjing University of Science and Technology, China.
Both of them have led me into the magic world of Economics and have directed me
academically throughout my graduate study.
I dedicate this dissertation to Mrs. Maoyun Lu, my mother. Without her continuous
encouragement and strong beliefs, I could not have dreamed of pursuing the Ph.D.
away from home. Thanks for showing me how wonderful the world is. Thanks for
teaching me how to give and forgive; I am deeply indebted to her for keeping me in
good health and great spirits.
Abbreviations
AE
Allocative Efficiency
AR
Auto Regression
AREAER Annual Report on Exchange Arrangements and Exchange Restrictions
BK
Baxter-King
CRS
Constant Return to Scale
CE
Cost Efficiency
DFA
Distribution Free Approach
DMU
Decision Making Unit
DEA
Data Envelopment analysis
DPD
Dynamic Panel Data
EE
Economic Efficiency
GDP
Gross Domestic Product
GMM
Generalized Method of Moments
GNI
Gross National Income
HP
Hodrick-Prescott
IAS
International Accounting Standard
IMF
International Monetary Fund
LFI
Less Financially Integrated
LM
Lagrange Multiplier test
MFI
More Financially Integrated
MLE
Maximum Likelihood Estimation
MPI
Malmquist Productivity Change Index
NBER
National Bureau of Economic Research
OECD
Organization for Economic Co-operation and Development
OLS
Ordinary Least Squares
SD
Standard Deviation
SE
Scale Efficiency
SFA
Stochastic Frontier Analysis
TE
Technical Efficiency
TFA
Thick Frontier Approach
TFP
Total Factor Productivity
VRS
Variable Returns to Scale
WDI
World Development Indicator
2SLS
Two Stage Least Squares
3SLS
Three Stage Least Squares
Table of Contents
Chapter I: Introduction ....................................................... Error! Bookmark not defined.
1.1 Statement of Problems...........................................Error! Bookmark not defined.
1.2 Chapter Organization ...........................................Error! Bookmark not defined.
Chapter II: Banking Sector Openness and Economic GrowthError! Bookmark not defined.
2.1 Introduction ........................................................... Error! Bookmark not defined.
2.2 Literature Review .................................................. Error! Bookmark not defined.
2.3 Methodology ......................................................... Error! Bookmark not defined.
2.3.1 Panel Data Analysis ....................................Error! Bookmark not defined.
2.3.2 General Method of Moments (GMM) ........Error! Bookmark not defined.
2.3.2.1 First Difference GMM and Systematic GMMError! Bookmark not defined.
2.3.2.2 One Step and Two Step System GMMError! Bookmark not defined.
2.4 Models and Data ................................................... Error! Bookmark not defined.
2.4.1Direct link .................................................... Error! Bookmark not defined.
2.4.2 Indirect Link................................................Error! Bookmark not defined.
2.4.3 Data Source .................................................Error! Bookmark not defined.
2.5 Empirical Analysis ................................................Error! Bookmark not defined.
2.5.1 Direct link ................................................... Error! Bookmark not defined.
2.5.1.1 Data Description ............................... Error! Bookmark not defined.
2.5.1.2 Test Results Analysis ........................ Error! Bookmark not defined.
2.5.1.3 Developed and Developing CountriesError! Bookmark not defined.
2.5.2 Indirect Link................................................Error! Bookmark not defined.
2.5.2.1 Data Description ............................... Error! Bookmark not defined.
2.5.2.2 Test Results Analysis ........................ Error! Bookmark not defined.
2.5.2.3 Developed and Developing CountriesError! Bookmark not defined.
2.6 Conclusions ........................................................... Error! Bookmark not defined.
Chapter III: The measurements of banking efficiency.......Error! Bookmark not defined.
3.1 Introduction ........................................................... Error! Bookmark not defined.
3.2 Literature Review .................................................. Error! Bookmark not defined.
3.2.1 Literatures of Banking Efficiency in a Single CountryError! Bookmark not defined.
3.2.2 Literatures of Banking Efficiency across CountriesError! Bookmark not defined.
3.3 Methodology ......................................................... Error! Bookmark not defined.
3.3.1 Parametric and Non-parametric Frontier MethodsError! Bookmark not defined.
3.3.2 Data Envelopment Analysis (DEA) ............Error! Bookmark not defined.
3.3.2.1 Input-orientations .............................. Error! Bookmark not defined.
3.3.2.2 Variable Returns to Scale (VRS) ......Error! Bookmark not defined.
3.3.2.3 Multi-stage Model ............................. Error! Bookmark not defined.
3.3.2.4 The Malmquist Index ........................ Error! Bookmark not defined.
3.3.3 Stochastic Efficient Frontier analysis (SFA)Error! Bookmark not defined.
3.3.3.1 Cost Frontier .....................................Error! Bookmark not defined.
3.3.3.2 Translog Function ............................. Error! Bookmark not defined.
3.3.3.3 Half Normal Distribution .................. Error! Bookmark not defined.
3.3.3.4 Other Assumptions............................ Error! Bookmark not defined.
3.4 Variables and Data ...............................................Error! Bookmark not defined.
3.4.1 Production Approach and Intermediation ApproachError! Bookmark not defined.
3.4.2 SFA Model .................................................. Error! Bookmark not defined.
3.4.3 DEA Model .................................................Error! Bookmark not defined.
3.4.4 Data Description .........................................Error! Bookmark not defined.
3.5 Empirical Results .................................................. Error! Bookmark not defined.
3.5.1DEA Model .................................................. Error! Bookmark not defined.
3.5.1.1Cost Efficiency of Banking Sectors ...Error! Bookmark not defined.
3.5.1.2 Malmquist Productivity Indices (MPI)Error! Bookmark not defined.
3.5.2 SFA Model .................................................. Error! Bookmark not defined.
3.5.2.1 Cost Inefficiency of Banking SectorsError! Bookmark not defined.
3.5.2.2 Maximum Likelihood Estimates .......Error! Bookmark not defined.
3.6 Efficiency and Growth...........................................Error! Bookmark not defined.
3.6.1 Introduction and Literature Review ............Error! Bookmark not defined.
3.6.2 Methodology and Model ............................. Error! Bookmark not defined.
3.6.3 Empirical Analysis ......................................Error! Bookmark not defined.
3.7 Conclusions ........................................................... Error! Bookmark not defined.
Chapter IV: Banking Sector Openness and Economic VolatilityError! Bookmark not defined.
4.1 Introduction ........................................................... Error! Bookmark not defined.
4.2 Literature review ................................................... Error! Bookmark not defined.
4.3Methodology .......................................................... Error! Bookmark not defined.
4.3.1Hodrik-Prescott Filter (HP).......................... Error! Bookmark not defined.
4.3.2General Method of Moments (GMM) .........Error! Bookmark not defined.
4.4Models and Data .................................................... Error! Bookmark not defined.
4.4.1Economic Growth and Economic Volatility Error! Bookmark not defined.
4.4.1.1Crisis Volatility and Normal Volatility ......Error! Bookmark not defined.
4.4.2 Banking Sector Openness and Economic VolatilityError! Bookmark not defined.
4.4.3 Relative Openness .......................................Error! Bookmark not defined.
4.4.4 Data Description .........................................Error! Bookmark not defined.
4.5Empirical analysis .................................................Error! Bookmark not defined.
4.5.1Economic Growth and Economic Volatility Error! Bookmark not defined.
4.5.2Banking Sector Openness and Economic VolatilityError! Bookmark not defined.
4.5.3 Relative Openness .......................................Error! Bookmark not defined.
4.6 Conclusions ........................................................... Error! Bookmark not defined.
Chapter V: Conclusions ..................................................... Error! Bookmark not defined.
5.1 Contributions and Policy Suggestions .................. Error! Bookmark not defined.
5.2 Limitations ............................................................ Error! Bookmark not defined.
5.3 Future Extensions .................................................Error! Bookmark not defined.
5.4 Summary ............................................................... Error! Bookmark not defined.
Appendix ............................................................................Error! Bookmark not defined.
Bibliography ......................................................................Error! Bookmark not defined.
List of Tables
Table 2.1 List of Countries and Banking Sector OpenessError! Bookmark not defined.
Table 2.2 Direct Link between Economic Growth and Foreign Bank Share GMM
System Estimator ................................................Error! Bookmark not defined.
Table 2.3 Developed countries Direct Link between Economic Growth and
Foreign Bank Share GMM System Estimator ....Error! Bookmark not defined.
Table 2.4 Developing Countries: Direct Link between Economic Growth and
Foreign Bank Share GMM System Estimator ....Error! Bookmark not defined.
Table 2.5 Annual Averages of Banking Efficiency VariablesError! Bookmark not defined.
Table 2.6 Countries’ Average of Banking Efficiency VariablesError! Bookmark not defined.
Table 2.7 Indirect Link between Foreign Bank Share and Efficiency of Banking
Sector GMM System Estimator .......................... Error! Bookmark not defined.
Table 2.8 Developed Countries: Indirect Link between Foreign Bank Share and
Efficiency of Banking Sector GMM System EstimatorError! Bookmark not defined.
Table 2.9 Developing Countries: Indirect Link between Foreign Bank Share and
Efficiency of Banking Sector GMM System EstimatorError! Bookmark not defined.
Table 2.10 Data Description .................................................... Error! Bookmark not defined.
Table 3.1 List of Countries and Number of Banks .....Error! Bookmark not defined.
Table 3.2 Statistic Summary of Developed and Developing CountriesError! Bookmark not defined
Table 3.4 Mean Efficiency Score of DEA Model of CountriesError! Bookmark not defined.
Table 3.5 Summary of Malquist DEA Index Analysis Error! Bookmark not defined.
Table 3.6 Summary of Malquist DEA Index Analysis Error! Bookmark not defined.
Table 3.7 Mean Inefficiency Score of SFA Model of CountriesError! Bookmark not defined.
Table 3.8 Mean Cost Inefficiency Score of SFA Model of YearsError! Bookmark not defined.
Table 3.9 Maximum Likelihood Estimation for the SFA FunctionError! Bookmark not defined.
Table 3.10 Direct Link between Economic Growth and Foreign Bank Share
GMM System Estimator .....................................Error! Bookmark not defined.
Table 3.11 Indirect Link between Foreign Bank Share and Efficiency of Banking
Sector GMM System Estimator .......................... Error! Bookmark not defined.
Table 3.3 Statistic Summary of Stochastic Frontier ............ Error! Bookmark not defined.
Table 4.1 GDP growth rate and output gap growth rateError! Bookmark not defined.
Table 4.2 Countries’ GDP Growth Volatility ..............Error! Bookmark not defined.
Table 4.3 All Countries’ Annual Average GDP Growth VolatilityError! Bookmark not defined.
Table 4.4 Developed Countries’ Annual Average GDP Growth VolatilityError! Bookmark not defin
Table 4.5 Developing Countries’ Annual Average GDP Growth VolatilityError! Bookmark not defin
Table 4.6 Correlations between Normal Volatility and Crisis VolatilityError! Bookmark not defined
Table 4.7 All Countries Link between Economic Growth and Economic VolatilityError! Bookmark
Table 4.8 Developed Countries’ Link between Economic Growth and Economic
Volatility ............................................................. Error! Bookmark not defined.
Table 4.9 Developing Countries Link between Economic Growth and Economic
Volatility ............................................................. Error! Bookmark not defined.
Table 4.10 Developed Direct Link between Normal and Crisis Volatility and
Banking Sector Openness ...................................Error! Bookmark not defined.
Table 4.11 Developing Countries’ Link between Normal and Crisis Volatility and
Banking Sector Openness ...................................Error! Bookmark not defined.
Table 4.12 Developed Countries’ Direct Link between Normal and Crisis
Volatility and Trade Openness............................ Error! Bookmark not defined.
Table 4.13 Developing Countries’ Direct Link between Crisis Volatility and
Trade Openness ................................................... Error! Bookmark not defined.
Table 4.14 Relative Openness .....................................Error! Bookmark not defined.
Table 4.15 All Countries Direct Link between Crisis Volatility and Banking
Sector Openness .................................................. Error! Bookmark not defined.
Table 4.16 Developed and Developing Countries Link between Crisis Volatility
and Relative Openness ........................................Error! Bookmark not defined.
Table 4.17 All Countries Non-linear Link between Crisis Volatility and Relative
Openness ............................................................. Error! Bookmark not defined.
Table 4.18 Developed and Developing Countries Non-linear Link between Crisis
Volatility and Relative Openness........................ Error! Bookmark not defined.
Table 4.19 Data Description .......................................Error! Bookmark not defined.
List of Figures
Figure 2.1 Developed and Developing Countries Banking Sector opennessError! Bookmark not defined
Figure 3.1 Technical and Allocative Efficiency Input OrientationError! Bookmark not defined.
Figure 3.2 Technical and Allocative Efficiency Output OrientationError! Bookmark not defined.
Figure 3.3 Production Frontier under CRS and VRS ........Error! Bookmark not defined.
Figure 3.4 Malmquist Productivity Index .......................... Error! Bookmark not defined.