The effect of financial innovation in the stock market on economic growth at different levels of good governance

Document Type : Original Article

Authors

• Samira Farajollahzade ¹
• Ahmad Sadraei Javaheri ²
• sakine owjimehr ³

¹ Master of economics, Department of Economics, Shiraz University, Shiraz, Iran

² Associate Professor, Department of Economics, Shiraz University, Shiraz, Iran

³ Assistant Professor, Department of Economics, Shiraz University, Shiraz, Iran

https://doi.org/10.22067/erd.2023.76086.1108

Abstract

1- INTRODUCTION
    Financial innovation includes new financial instruments, the creation of new corporate structures, the formation of new financial institutions, the development of new methods of financial accounting and reporting. Such improvements in the financial system are key to financial productivity along with economic growth. It seems that the institutional conditions can affect how the development of financial markets affects economic growth. This is important in all countries, but it can be even more important in developing countries, usually not at the desired level of good governance index. In addition, another point that has been neglected in literature is the consideration of new financial instruments in the stock market. One of the financial innovations in the stock market is exchange-traded fund (ETF). The ETF allows the investor to have a diverse and low-risk portfolio. With this new instrument, passive funds are made available to investors.
In sum, considering the existing study gap, the present study examines the impact of financial innovation on the economic growth of developing and developed countries by considering the institutional quality.
 
2- THEORETICAL FRAMEWORK
There are six significant functions to financial innovation: Transfer funds, collect funds, manage risk, extract information to support decision making, address information asymmetry, and facilitate the purchase and sale of goods and services through the payment system. There should be no institutional, political, or regulatory barriers to financial innovation in performing these tasks. At best, government incentives should be set up to promote financial innovation.
Researchers examine the economic impact of financial innovation from two perspectives: The growth and innovation perspective and the fragility and innovation perspective. The growth and innovation perspective states that financial innovation improves the process of financial intermediation and, in turn, stimulates economic growth. The innovation and fragility perspective states that financial innovation leads to a more fragile and vulnerable financial system; therefore, it is an obstacle to economic growth. There is no consensus on which view is dominant.
Some studies show that innovation in the financial system can accelerate Bangladesh's economic growth through a positive effect on financial development and economic resources. Some studies, use research and development costs in the financial sector as a proxy for financial innovation and show that innovations are likely to contribute to economic growth, and incorrect regulation can be a barrier to growth. Another study shows that financial innovation (Financial Innovation Expenditures) significantly impacts economic growth.
Researchers believe that institutions, laws, regulations, and policies are essential for influencing financial innovation in the economy. Countries that encourage financial innovation accelerate the convergence of their economies into technology growth rates. Some studies also showed that financial innovation's impact is more substantial in countries with more security markets. Financial innovation positively affects growth in countries with more constraints on bank performance.
 
3- METHODOLOGY
We use a dynamic threshold panel model to investigate the nonlinear effect of financial innovation on economic growth.
 
4- RESULTS & DISCUSSION
The value of the threshold parameter in this study is 1.67, which is located between the lower (1.64) and upper (1.68) limits and is significant at the 10% confidence level. According to the results, the economic growth whit one lag variable with a coefficient of 0.28 has a positive and significant effect on economic growth. Significance of the effect of economic growth with a lag on economic growth indicates the dynamics of the behavior of this variable. The good governance index, which is considered as a threshold variable in this study, plays a role in the impact of financial innovation on economic growth. Thus, when the level of good governance index is lower than the threshold level, the effect of financial innovation on economic growth is 0.02 and when the level of good governance index is higher than the threshold level, the effect of financial innovation on economic growth is more and 0.04.
 
5- CONCLUSIONS & SUGGESTIONS
The present study results show that in the impact of financial innovation on economic growth, governments and economic institutions' role in enforcing laws related to good governance indicators cannot be ignored. Since the financial innovation in the stock market has a positive impact on economic growth, this effect has different consequences under the lower and upper levels of governance. In other words, financial innovation is meaningful and has a more substantial impact when good governance practices are implemented at higher levels; therefore, governments should strive to implement the criteria of good governance better. However, because countries differ in their institutional environment and definition of good governance indexes, implementing these practices may not produce the same results.

Keywords

• Dynamic Panel Threshold Model
• Economic Growth
• Financial Innovation

References

Arellano, M., & Bovver, O. (1995). Another Look at the Instrumental Variables Estimation of Error – Components Models. Journal of Econometrics, 68, 29 – 51.

Anderson, T. W., & Hsiao, C. (1981). Estimation of Dynamic Models with Error Components. Journal of the American Statistical Association, 76(375), 598 – 606.

Arslan, M., & Alqatan, A. (2020). Role of Institutions in Shaping Corporate Governance System: Evidence from Emerging Economy. Heliyon 6, 1 – 17.

Beck, T., Chen, T., & Song, F.M. (2016). Financial Innovation: The Bright and the Dark Sides. Journal of Banking and Finance, 28- 51.

Bernier, M., & Plouffe, M. (2019). Financial Innovation, Economic Growth, and the Consequences of Macroprudential Policies. Research in Economics, 162- 173.

Caner, M., & Hansen, B. E. (2004). Instrumental Variable Estimation of a Threshold Model. Econometric Theory, 20, 813 – 843.

Donyayi, M., Hosseini, S. (2013). Investigating the Role of Iran’s OTC Market in the Development of Trading Innovations in the Capital Market. Quarterly Journal of Securities Financial Knowledge, 5(16), 137 – 149. (In Persian)

Ebrahimi, B., Vaez Borzani, M., Dallali Esfahani, R., & Fakhar, M., (2016). Experimental Study of Qualitative Development on Economic Growth (Case of Iran). Journal of Economic Growth and Development, 6(22), 71 - 84. (In Persian)

Ehsani, M., Ezadi, R & Kordtabar, H. (2014). Investigating the Effect of Stock Market Development on Economic Growth: A Case Study in D8 Countries. Quarterly Journal of Fiscal and Economic Policies, 2(6), 105 – 122. (In Persian)

Fontin, J. R. & Lin, Sh. W. (2019). Comparison of Banking Innovation in Low-Income Countries: A Meta Frontier Approach. Journal of Business Research, 97, 198 – 207.

Fournier, J. M, & Johansson, A. (2016). The Effect of Size and the Mix of Public Spending on Growth and Inequality, OECD Economics Department Working Paper, OECD Publishing Paris, No. 1344.  

Galindo, M. Á., & Méndez, M. T. (2014). Entrepreneurship, economic growth, and innovation: Are feedback effects at work? Journal of business research, 67(5), 825-829.

Googerdchiyan, A., Fathi, S., Amiri, H., & Saeedi Varnamkhasti, N. (2015). Comparative Analysis of the Impact of Political Risk on the Stock Market Development of Selected Countries. Investment Knowledge Quarterly, Iranian Financial Engineering Association, 4(15), 135 – 156. (In Persian)

Guillemette, Y., Kopin, A., Turner, D., & Mauro, D. (2017). A Revised Approach to Productivity Convergence in Long- term Scenarios. OECD Economics Department Working, Papers no 1385.

Hadri, K., & Rao, Y. (2008). Panel Stationarity Test with Structural Breaks. Oxford Bulletin of Economics and Statistics, 70(2), 245 – 269.

Hansen, B. (1999). Threshold Effects in Non- Dynamic Panels: Estimation, Testing and Inference, Journal of Econometrics, 93, 345- 368.

Hasanzade, A., & Ahmadian, A. (2011). The Effect of Stock Market Development on Economic Growth. Money and Economics Quarterly, 2, 31 – 52. (In Persian)

Hu, Y., Guo, D., Deng, Y & Wang, S. (2014). Estimation of Nonlinear Dynamic Panel Data Models with Individual Effects. Mathematical Problems in Engineering, 1-7.

Idun, A. A. A., & Aboagye, A. Q. Q. (2014). Bank Competition, Financial Innovations and Economic Growth in Ghana. African Journal of Economic and Management Studies, 5(1), 30 – 51.

Komijani, A. A., & P., Salatin. (2009). Effects of Good Governance on Economic Growth in the Selected Countries of OPEC and OECD. Economical Modeling, 2(6), 1-24. (In Persian).

Kremer., S., Bick, A., & Nautz, D. (2013). Inflation and Growth: New Evidence from a Dynamic Panel Threshold Analysis. School of Business & Economics, 1- 22.

Lee, Ch. Ch., Wang, Ch. W., & Ho, Sh. J. (2020). Financial Innovation and Bank Growth: The Role of Institutional Environment. North American Journal of Economics and Finance, 1- 23.

Levin, R. (1999). Financial Development and Economic Growth: Views and Agenda, The World Bank.

Merton, R. C. (1992). Financial Innovation and Economic Performance. Journal of Applied Corporate Finance, 4(4). 12- 22.

Mishkin, F. S. (2016). The Economics of Money, Banking and Financial Markes, 11 editions.

Minhua, Y., & Yu, H. (2019). How Does the Stock Market React to Financial Innovation Regulations? Finance Research Letters, 259- 265.

Mohammadi, H.; Mohammadi, M. &Tirgari, M. (2017). Study of Factors Affecting Per capita Production Growth in Different Income Groups in the World with Emphasis on Governance Characters ". Quarterly Journal of Economic Modeling Research, Volume No, 30. 109-145. (In Persian).

Mohammadzadeh, P., Khangaldizadeh, S., & Kamangar, S. (2020). The Impact of Innovation and Entrepreneurship on Economic Growth: An Intercountry Study. Iranian Journal of Economic Research, 25(82), 121-148. doi: 10.22054/ijer.2020.11912. (In Persian).

Mollaahmetoglu, E., & Akcali, B. Y. (2019). The Missing-Link Between Financial Development and Economic Growth: Financial Innovation. Procedia Computer Science, 696–704.

Namazi, M., & Moghimi, F. (2019). Investigating the Mediating Role of Innovation Challenges in the Relationship Between Innovation Structures and Firm Financial and Economic Performance. Financial Accounting Research, 10(24), 79 – 103. (In Persian)

Pesaran, M.H. (2004). General Diagnostic Tests for Cross Section Dependence in Panels. Empirical Economics, 1 – 39.

Pesaran, M. H., & T. Yamagata. (2008). Testing slope homogeneity in large panels. Journal of Econometrics 142(1): 50–93.

Pesaran, M., & R. Smith. (1995). Estimating long-run relationships from dynamic heterogeneous panels. Journal of Econometrics 68(1): 79–113.

Pradhan, R.P., Arvin, M. B., Nair, M., Bennett, S. E., Bahmani, S., & Hall, J. H. (2018). Endogenous Dynamics Between Innovation, Financial Markets, Venture Capital and Economic Growth: Evidencefrom Europe. Journal of Multinational Financial Management, 45, 15 – 34.

Qamruzzaman, M. D., & Jianguo, W. (2017). Financial Innovation and Economic Growth in Bangladesh. Financial Innovation, 7(3), 1- 24.

Sadeghi Kelidsar, Z., & Mirzapoor Babajan, A. (2018). Investigating the Relationship Between Stock Market Development and Economic Growth in Iran with a Nonlinear Model. Journal of Development and Transformation Management, 34, 81 – 90. (In Persian)

Tahir, S. H., shah, S., Arif, F., Ahmad, G., Aziz, Q., & Ullah, M. R. (2018). Does Financial Innovation Improve Performance? An Analysis of Process Innovation Used in Pakistan. Journal of Innovation Economics & Management, 195- 214.

Zhu, X., Asimakopoulos, S., & Kim, J. (2020). Financial Development and Innovation-Led Growth: Is Too Much Finance Better? Journal of International Money and Finance, 1- 24.