Financial liberalisation and economic growth in sub-Saharan African countries : dilemmas and prospects

ENGLISH ABSTRACT: This dissertation examines the dynamic effects of financial liberalisation on economic growth in three sub-Saharan African countries - Kenya, South Africa and Tanzania. The study was motivated by the current debate on the efficacy of financial liberalisation on the one hand and the painful experience some of these countries have had with the liberalisation of the financial sector on the other. Three critical questions are asked. Does financial liberalisation contribute positively towards increased economic growth through its influence on savings, financial deepening, and investment efficiency? Is the mechanism through which financial liberalisation affects economic growth in the study countries based on the volume or efficiency of investment? Does financial development, which results from financial liberalisation, Granger cause economic growth? Cointegration and error-correction techniques are used to investigate empirically the dynamic link between financial liberalisation and economic growth. The error-correction mechanism used is based on the Hendry and Ericson's (1991) general to specific model. In addition, the study uses a dynamic causality test based on the vector error correction model to examine the existence and the direction of causality between financial development and economic growth in the study countries. The theoretical and empirical underpinning of financial liberalisation as well as the controversies, challenges, and paradoxes that have emerged in the literature since the onset of financial liberalisation in the 1970s are also explored. Finally, the experiences of the study countries with financial liberalisation are reviewed in order to relate these experiences to the presumptions of the theoretical literature on the one hand, and to serve as a precursor to the econometric investigations on the other. Contrary to the results obtained from some previous studies, the results of this study indicate a strong support for McKinnon's complementarity hypothesis in Kenya, South Africa and Tanzania. The results apply irrespective of whether money demand and savings functions are estimated in static cointegration regression or in the dynamic formulation (error-correction model). This implies that the more attractive financial assets are the greater the incentives to invest in the study countries. The findings of the study also provide abundant support for the positive impact of financial liberalisation on financial deepening in the study countries. However, the impact of financial liberalisation on investment efficiency is not the same in the three study countries. Although financial liberalisation seems to positively influence investment efficiency in Kenya, it fails to influence in a robust manner the level of investment efficiency in South Africa and Tanzania. The results on the long-run causality between financial development and economic growth indicate that the direction of causality is sensitive to the choice of measurement for financial development. On balance, a demand-following response is found to be stronger in South Africa and Kenya, while a supply-leading response is found to be stronger in Tanzania. In conclusion, it is worth mentioning that, while the positive role of financial liberalisation on economic growth through its influence on savings, financial deepening and investment efficiency is overwhelming, the clarity and strength of this beneficial role differs from country to country and over time.