Baltagi paper on financial development and openness published in Journal of Development Economics

Jun 30, 2009

Financial Development and Openness: Evidence from Panel Data

Badi H.Baltagi, Panicos O.Demetriades & Siong Hook Law

Journal of Development Economics, June 2009

Badi H. Baltagi

Economics Department

Center for Policy Research

Trade

Journal of Development Economics

Badi H. Baltagi

This paper addresses the empirical question of whether trade and financial openness can help explain the recent pace in financial development, as well as its variation across countries in recent years. Utilising annual data from developing and industrialised countries and dynamic panel estimation techniques, the authors provide evidence which suggests that both types of openness are statistically significant determinants of banking sector development. Their findings reveal that the marginal effects of trade (financial) openness are negatively related to the degree of financial (trade) openness, indicating that relatively closed economies stand to benefit most from opening up their trade and/or capital accounts. Although these economies may be able to accomplish more by taking steps to open both their trade and capital accounts, opening up one without the other could still generate gains in terms of banking sector development. Thus, the authors' findings provide only partial support to the well known Rajan and Zingales hypothesis, which stipulates that both types of openness are necessary for financial development to take place.