IMPACT OF FINANCIAL INTERMEDIATION ON ECONOMIC DEVELOPMENT OF SUB SAHARAN AFRICAN COUNTRIES

IMPACT OF FINANCIAL INTERMEDIATION ON ECONOMIC DEVELOPMENT OF SUB SAHARAN AFRICAN COUNTRIES

Abstract

Sub-Saharan African countries are still at the crossroad of economic performance. Despite quarter of a century of economic reforms, propagated by national policies and international financial agencies and institutions, sub-Saharan Africa is still lagging behind in development. Once thought of as an area with huge potential for economic growth, sub-Saharan African countries are now representing the poorest and least developed populations of the world due largely to skewed economic development polices which are not geared towards sustainability. Economic development must be sustainable, implying that it should be on-going and dynamic in order to achieve the goal of poverty alleviation. A review of literature indicates that studies in area of economics and finance have focused on the impact of finance on economic growth arising more from developed economies. Recommendations from these works may obviously have favoured these economies to the detriment of the developing ones, sub Saharan African countries inclusive. Such policies nonetheless are growth oriented as opposed to the more development oriented policies which developing countries need at least to salvage their numerous poor. Sub Saharan African countries need not only grow but to develop especially as financial intermediation is taking place in their economies. It is therefore in this context that for economies of sub Saharan African countries to grow, studies that will examine the impact of financial intermediation on economic development should be used as the basis for formulating economic policies for the structural transformation of their economies. It is therefore against the foregoing that this study sought to examine the impact of financial intermediation on quality of life; human development; per capita real income; gross domestic product and employment creation in Sub Saharan African countries. The study adopted the ex-post facto research design.

Panel data set were collated from the World Bank for 49 sub Saharan African countries for the period, 1980 – 2012. Five (5) hypotheses which state that financial intermediation does not have positive and significant impact on the quality of life; human development; per capita real income; gross domestic product growth rate; employment creation in sub Saharan African countries were formulated and tested using the Ordinary Least Squares (OLS) technique. Credit to the private sector (FIM) was adopted as the independent variable and physical quality of life index (PQLI), human development index (HDI), per capita income (PCI), growth rate of gross domestic product (GDPGR) and unemployment index (UEI) were the dependent variables for the hypotheses respectively. Capital stock (CS) and trade stock (TS) were introduced as control variables. The result emanating from this study was mixed on the development indicators. While physical quality of life and per capital income was found to have positive and significant impact on economic development, human development index, gross domestic product growth rate and unemployment creation had negative and significant impact. The study, therefore, concludes that for the economies of sub Saharan African countries to develop, emphasis should be placed on developing and implementing policies that will address critical areas like health, education, agriculture, energy, infrastructural development etc as these are development oriented goals that can move the region forward. We thus recommend, among others, that governments in the sub region should prioritize investments in these areas. This would assist in addressing the problems of underdevelopment observed in the region.

CHAPTER ONE

1.0       INTRODUCTION

1.1       Background of Study

Over the past half century, developmental economics has undergone many changes as emphasis has shifted from the growth in gross domestic product (GDP) per capita (Morawetz, 1977), to employment creation (Lewis 1954; Kuzent, 1955), to basic human needs (see, Goldstein, 1985), to stabilization and structural adjustment (see, Jhingan, 1984), to human capabilities and development (Sen, 1989), and recently, to sustainable development (World Development Report, 1999-2000).

These changes in developmental economic policies over time from growth in GDP per capita to sustainable development could be attributed to the desire of nations to address the problem of poverty which is predominant in less developed economies of the world (Sub Saharan African countries inclusive). The Brundtland report of the World Commission on Environment and Development in 1987 however brought to limelight the concept of sustainable development as the report defined it as “meeting the needs of the present generation without compromising the need of the future generation” (Jhingan 2012:12). Thus, economic development must be sustainable implying that it should be on-going and dynamic in order to achieve the goal of poverty eradication.

The World Development Report (1999-2000) emphasizes the creation of sustainable improvement in the quality of life for all persons as the principal goal of development policy. According to the report, sustainable development has many objectives; beside increasing economic growth, meeting basic needs, and lifting the standard of living of citizens, it also include a number of specific goals such as; bettering people’s health and educational opportunities, giving everyone the chance to participate in public life, helping to ensure a clean environment, promoting intergenerational equality and much more (World Commission, 1999- 2000).

Thus, meeting the need of the people in the present generation is essential in order to sustain the needs of future generations and the ability of developing economies to achieve these objectives hinges on her ability to enhance rate of savings, profit rate, rate of capital accumulation, technical improvement, equitable distribution of wealth, expansion of foreign trade and institutional changes, etc (Jhingan, 2012). Among all the factors of economic development, the rate of savings and capital accumulation has been described as one of the most important and necessary conditions to the achievement of economic development of nations. No wonder from Smith (1776) to Kings and Levine (1993), it has been argued that finance plays an important role in the enhancement of economic development through its financial intermediation (savings and capital accumulation) function.

From the classical economic perspective, Smith (1976) regards every person within the society as the best judge of his/her self interest who should and must be left alone to pursue it to his/her own advantage. In furthering their personal interest, the interest of the society is enhanced through the invisible hand mechanism. Smith (1776) regards financial intermediation (capital accumulation) as a necessary condition for economic development and opines that the process of economic development was largely as a result of the ability of the people to save more and invest more in their country, thus, Smith (1776) summaries that in any society every prodigal appears to be a public enemy and every frugal man a public benefactor (Jhingan, 2012:87).

In line with the above statement, therefore, the level of capital accumulation through savings is principally a necessary condition for economic development of nations. Malthus (1836) also made mention of the role of financial intermediation on economic development. However, he was concerned with the progress of wealth which means economic development that could be achieved by increasing, the wealth of a country. According to Malthus (1836), of all the factors of production which are necessary condition for economic development, it is the accumulation of capital that is the most important determinant of economic development. It was against this background that he suggests the concept of the optimum propensity to save. This means saving from the stock which might have been destined for immediate consumption thereby adding to that which is to yield profit or in other words in the conversion of revenue into capital (Malthus, 1836)

Mills (1871) emphasizes the role of finance in the enhancement of economic development of nations. According to Mills (1871) economic development is a function of land, labour and capital and while land and labour are the two original factors of production, capital is a stock previously accumulated of the products of former labour. According to Mills (1871), the rate of capital accumulation depends upon the amount of the fund which savings can be made or the size of the net produce of industry and the strength of the disposition to save. Therefore, capital is the result of savings and savings comes from the abstinence from present consumption for the sake of future goods. Thus for nations to achieve sustainable development, there must be an effective desire to accumulate capital (Mill, 1871).

Like Smith (1776), Ricardo (1917) highlights the connection between financial intermediation and economic development however, he pointed towards the importance of capital accumulation through agricultural development and increase in the various sources of saving and profit rate.

According to Ricardo (1917) capital accumulation which is a process of financial intermediation is the outcome of profits as profits lead to saving of wealth which is used for capital formulation and this is dependent on the capacity to save and the will to save. Thus, for any economy to develop, such economy must enhance her capacity to save.

Karl Marx, according to Jhingan (2012), discusses the connection between financial intermediation and economic development. Marx refers to financial intermediation which he called the surplus value as a process of economic development. According to Marx, every society’s class structure consists of the “have’ and “have not” and states that since the mode of production is subject to change, a stage will come in the development process of nations when the forces of production will come into clash with the society’s class structure. This will eventually lead to class struggle which ultimately will overthrow the whole social system. Thus,

Marx used his theory of surplus value as the economic basis of the class struggle under capitalism to building the super structure of his analysis of the process of economic development (see Jhingan, 2012).

Schumpeter (1911) also discusses the importance of financial intermediation in the enhancement of economic development. According to Schumpeter (1911), economic development is a spontaneous and discontinuous change in the channel of the circular flow, disturbances of equilibrium which forever alters and displaces the equilibrium state previously existing.

Schumpeter (1911), thus states that, economic development starts with the breaking-up of the circular flow (stationary state) with an innovation in the form of a new product by an entrepreneur for the purpose of earning profit. In order to break the circular flow, the innovating entrepreneurs are financed by bank-credit expansion (financial intermediation process).

Therefore, since investment is assumed to be financed by the creation of bank credit, it increases income and prices and this help to create a cumulative expansion throughout the economy thereby inducing economic development (Schumpeter (1911).

The Keynesians were also not left out at providing a link between financial intermediation and economic development. Though there link does not analyze the problems of underdeveloped economies it had relevance to advanced capitalist countries. According to Jhingan (2012), total income is a function of total employment in a country, thus, the greater the national income, the greater the volume of employment. Again, according to them the volume of employment depends on effective demand and effective demand determines the equilibrium level of employment and income. Therefore, for any economy, effective demand is determined at the point where demand price aggregate equals aggregate supply price. Effective demand according to the Keynesians consists of consumption demand and investment demand. While consumption demand depends on the propensity to consume, investment demand which is largely as a result of financial intermediation does not increase at the same level as the increase in income, hence, the gap between income and consumption is made up by investment which grows the economy (Jhingan, 2012).

Rostow (1960) also provides his own thought on the effect of financial intermediation on economic development. He sought and advocated a historical approach to the process of economic development. He distinguished five stages of economic development viz a viz the traditional society, the pre-conditions for take-off, the take-off, the drive to maturity and the age of high maturity consumption. According to Rostow (1960) while the traditional society is based on one whose structure is developed within the limited production functions based on pre-

Newtonian science and technology, the pre-condition take-off stage is based on the idea that economic progress is possible and is a necessary condition for some other purpose, judged to be good. Therefore, at this stage, new types of enterprising men come forward in the private economy, in government or both willing to mobilize savings (financial intermediation) and to take risks in pursuits of profits to modernization (economic development). Emphasizing the role of financial intermediation on economic development, Rostow (1960) summarized that: …as banks and other institutions for mobilizing capital appears, investment increase, notably in transport, communication and in raw materials in which other nations may have an economic interest. The scope of commerce, internal and external widens and modern manufacturing enterprises appear using new methods… (Rostow, 1960:6-7) Gerschenkron (1962) also supports the importance of finance in the enhancement of economic development. According to Gerschenkron (1962), all nations were backward once, thus, to move from the traditional levels of economic backwardness to a modern industrial economy required a sharp break with the past. Gerschenkron (1962) categorized countries into three groups on the basis of their degree of economic backwardness: advanced, moderately backward and very backward. To put perspectives on the role of financial intermediation on the development of these economics Gerschenkron (1962) notes that advanced nations started their first stage of development with the factory as the organization lead; moderately backward nations starts with banks and extreme backward nations with government. However, as argued by Gerschenkron (1962), as a necessary precondition for development, financial institutions through the process of intermediation can play an important role in the achievement of economic development through the enhancement of capital accumulation.

Given the contributions of economists such as Smith, Ricardo, Malthus, Keynes, Rostow and Gerschenkron from 1776 to 1962, recent literature have also emphasized on the role of financial intermediation on economic development. Though these recent literature have emphasized more on economic growth rather than economic development. These recent literature have supported their argument with empirical results to buttress the impact of finance on economic growth. Leading recent literature in this regard is king and Levine (1993) who citing Schumpeter (1911) opines that the services provided by financial intermediaries (mobilizing savings, evaluating and facilitating transactions) are essential for technological innovation and economic development. It was against the importance of financial intermediaries in performing the above functions that king and Levine (1993) conducted a pooled cross country time series survey of eighty countries for the period 1960-1989 with the view to establishing the relationship between financial intermediation and economic growth. Their findings suggest that financial intermediation has a significant impact on growth.

Taking a cue from king and Levine (1993), Jayaratne and Strathan (1996) support the influence of financial intermediation on economic development though their emphasis were on development through growth, however, with a clause that there should be an improvement in the quality of bank lending and not necessarily the volume of bank lending. Contributing to these debates on finance and growth, Ragan and Zingales (1998) assert that financial development enhances growth in indirect ways through the contribution of external financing. Demirgue-Kunt and Maksimovic (1998) in supporting the role of finance on economic development were of the view that an active stock market is an indication of a well developed financial system and they assert that firms in a country with a high rate of compliance with rules and regulations have access to the capital market. Thus, a developed financial system will ensure growth of firms listed in the exchange thereby stimulating development. Amongst other recent works which have increased literature on finance and growth are Odedokun (1998), Levine, loayza and Beck (2000), McGaig and Stengos (2005), Hao (2006), Deidda (2006), Romeo-Avila (2007), Odhiambo (2008) and Shittu (2012) etc.

As stated earlier, a review of recent literature indicate that previous works in this area of economics and finance have focused on the impact of finance on economic growth which often are based on figures from developed economies. The adoption of recommendations from these works obviously may not have any significant effect on the economies of less developed countries (especially Sub Saharan African countries) because policy implication from economic growth oriented literature is quite distinct from economic development oriented literature because growth and development are two distinct words. Again, what developing economies need is economic development polices which encompasses growth if the high rate of poverty which is prevalent is to be conquered. Thus, as stated by Maddison (1970), economic development refers to the problems of underdeveloped countries and economic growth to those of developed countries. He summarized that …the rising of income level is generally called economic growth in rich countries and in poor ones it is called economic development. (Maddison, 1970:5).

However, this view does not specify the underlying forces which raise the income level in the two types of economies. Hicks (1957) points out in this connection that the problem of underdeveloped countries are concerned with the development of unused resources even though there are well know, while these of advanced countries are related to growth as most of their resources is already know and developed to a considerable extent.

It is against the background of the distinctions between development and growth that Kindleberger (1965) opines that while growth means more output, economic development implies both output and changes in the technical and institutional arrangement by which it is produced and distributed. Therefore, for economies of Sub Saharan African countries to grow, studies that will examine the impact of financial intermediation on economic development should be used as the basis for economic policies which will eventually induce the structural transformation of their economies.

It therefore against the foregoing that this study sought to examine the impact financial intermediation on economic development of sub Saharan African countries utilizing indicators of development such as the physical quality of life which is determined by three components (Infant mortality, life expectancy and basic literacy rate), human development index which is calculated using life expectancy at birth, educational attainment and decent standard of living, per capita income, the gross domestic product (GDP) measured at the purchasing power parity level of Sub Saharan African countries and employment rate for the period 1980 to 2012.

1.2       Statement of Problem

Sub-Saharan Africa countries are still at a crossroad of development. Despite a quarter of a century of economic reforms propagated by national policies and international financial agencies and institutions, Sub-Saharan Africa is still lagging in development. This region was thought of as an area with huge potential for economic growth; however, sub-Saharan Africa is now representing the poorest and least developed populations in the world and becoming the primary focus of international aid agencies (Tyler and Gopal, 2010). In 2001, Go et al. (2007) opine that sub-Saharan Africa had a poverty rate of 46.1 percent, the highest regional poverty rate in the world; therefore, this region represents 29 percent of the global population living on less than $1 per day.

Again, according to UN (2012) report, sub-Saharan Africa which comprises 49 countries, 47% of the people live on less than $1.25 a day. Although in 2011, the World Bank confirmed a positive declining trend in poverty, the level of poverty is still the highest in the world (World Bank, 2011). While there is large heterogeneity among countries in the sub regions, financial systems in most sub Saharan African countries has remained poorly developed relative to other regions with only 24% of the adult population having bank accounts at a formal financial institution which is half the global average. Banks and other deposit-taking institutions, like cooperatives, dominate financial systems in sub-Saharan Africa with regulated microfinance institutions though increasingly playing an important role in expanding access to financial services to low income earners is still not enough in sub Saharan African countries. According to Financial

Stability Board (FSB), International Monetary Fund (IMF), and World Bank (WB) (2011), the last couple of years have also witnessed the emergence of Pan-African banking groups expanding rapidly in the region with significant share of domestic deposits. This has resulted in increased local competition while infusing new technologies, products, and managerial techniques however; there is still an un-served group in rural areas that need such financial institutions. Though, mobile money is increasingly playing a role in expanding access in the region where 16% of adults are reported to use a mobile phone to pay bills or send or receive money but when compared to global average it is less than 5% (FINDEX 2012).

One of the major indicators of under-development in Sub Saharan African countries is high mortality rate. The level of mortality in a population can be measured by the number of deaths per thousand inhabitants, number of infant deaths per 1000 births and summary measure of death risks/ survival chances over different ages. Of these, the infant mortality rate is the most widely used indicator of the general health situation in a country. In the 1950s infant mortality rates in Asia were as high as in sub-Saharan Africa. According to Malmberg (2010) after 1960, the decline became more rapid in Asia, whereas the decline in sub-Saharan Africa continued at a slow pace and opines that the stall of the infant mortality rate decline during the last two decades of the 20th century can be seen as the result of a policy failure. One possible reason for low rates of improvements after 1980 could be the austerity measures imposed on many sub-Saharan countries by the IMF and the World Bank (Malmberg, 2010). Severe cuts in government budgets and large lay-offs of public employees seem to have had negative effects on programs aimed at health improvement. An alternative explanation is that the economic downturn was the key factor. What is clear is that sub-Saharan Africa during this period was unable to implement the kinds of broad-based health policies which have been so successful in reducing infant-mortality in Asia (Fort, Mercer et al. 2004).

According to the United Nations, as of the year 2008, there were 26 countries in the world that qualified as countries with “low human development” (United Nations Development Programme 2008b). Low human development is defined as a country with an HDI value of less than 0.5. Of the 26 countries, all but one (Timor-Leste) are located in sub-Saharan Africa. Not one country in contiguous sub-Saharan Africa (in other words excluding island states) is considered to have “high human development.” The country with the highest human development index (HDI) rating located in contiguous sub-Saharan Africa is Gabon, with an HDI value of 0.729 (United Nations Development Programme 2008a). To put this HDI value in perspective, countries with similar HDI values are the Philippines, Paraguay, Sri Lanka, and Jamaica (United Nations Development Programme 2008a). It is clear that along with the highest rates of poverty in the world and stagnant economic growth, sub- Saharan Africa is also home to the least educated and least healthy populations in the world.

It is therefore, against the need to explore the role of finance in tackling developmental issues in developing economies with bias to sub Saharan African countries that this study examined the impact of financial intermediation on economic development of sub Saharan African countries from 1980 to 2012 utilizing panel data set from the World Bank.

1.3       Objectives of the Study

The general objective of this study is to examine the impact of financial intermediation on economic development of sub Saharan African countries. However, the specific objectives of this study are:

1. To ascertain the impact of financial intermediation on the quality of life of sub Saharan African countries,
2. To assess the impact of financial intermediation on the level of human development of sub Saharan African countries,
3. To determine the impact of financial intermediation on the per capita real income of sub Saharan African counties,
4. To examine the impact of financial intermediation on gross domestic product of sub Saharan African countries, and
5. To ascertain the impact of financial intermediation on employment creation in sub Saharan African countries.

1.4       Research Questions

In order to empirically test the above objectives, the following research questions arose. There are:

1. To what extent does financial intermediation have positive and significant impact on the quality of life of sub Saharan African countries?
2. How far does financial intermediation play significant and positive impact on human development of sub Saharan African countries?
3. To what extent does financial intermediation have positive and significant impact on per capita real income of sub Saharan African countries?
4. How far does financial intermediations have positive and significant impact on gross domestic product growth rate of sub Saharan African countries?
5. To what extent does financial intermediation have positive and significant impact on employment creation in sub Saharan African countries?

1.5       Research Hypotheses

The following hypotheses were stated in null forms in this study. There are:

1. Financial Intermediation does not have positive and significant impact on the quality of life in sub Saharan African countries.
2. Financial Intermediation does not have positive and significant impact on human development in sub Saharan African countries.
3. Financial Intermediation does not have positive and significant impact on per capita real income of sub Saharan African countries.
4. Financial intermediation does not have positive and significant impact on gross domestic product growth rate of sub Saharan African countries
5. Financial intermediation does not have positive and significant impact on employment creation in sub Saharan African countries.

1.6       Scope of the Study

This study covered the period 1980 to 2012 and 47 Sub Saharan African countries were studied. According to Jhingan (2012), in the early eighties, the decline in the growth rate of developed countries, the rise in oil prices, the debt crisis in developing countries and the worsening of their terms of trade pushed the basic needs strategy in the background. Many countries embarked on programmes of stabilization and structural adjustments. Initially stabilization measures supported by the IMF and World Bank were aimed at reducing inflation, cutting public spending, reducing wages and raising interest rates. Goaded by the World Bank and IMF, many developing countries (including sub Saharan African countries) switched to long-term structural adjustment programmes. The programmes were domestically designed programme of reforms by following the policies of liberalization, adjustment and privatization. These involves reducing the role of the state, removing subsidies, liberalizing prices and opening economies to flows of international trade and finance. Most sub Saharan African countries adopted the structural adjustment programmes. Thus, this study examined the impact of financial intermediation on economic development from the period of structural adjustment programmes to this period of craving for sustainable development hence the scope of this study, hence, the use of 1980 as a base year is predicated on the era of structural adjustment programme among countries in the region. There are presently 49 in Sub Saharan African Countries and the sub Saharan African countries under focus in this study are Angola, Benin, Botswana, Burkina Faso, Burundi, Cameroun, Cape Verde, Central African Republic, Chad, Comoros, Congo Democratic Republic, Congo Republic, Cote d Ivoire, Equatorial Guinea, Eritrea, Ethiopia, Egypt, Gabon, Gambia, Ghana, Guinea Bissau, Libya, Liberia, Kenya, Lesotho, Malawi, Mauritius, Mauritania, Morocco, Mali, Madagascar, Mozambique, Namibia, Nigeria, Niger, Rwanda, Seychelles, Senegal, Somalia, South Africa, Sierra Leone, Sudan, South Sudan, South Tome and Principe, Swaziland, Tanzania, Uganda, Zambia, and Zimbabwe.

1.7       Significance of Study

This study will be significant to the following groups. There are:

1. Government Policy Makers

Monetary and fiscal policies play a significant role in accelerating development by influencing the cost of availability of fund, controlling credit, maintaining balance of payment equilibrium as well as taxation. Thus, this study will assist in providing government policy makers with the necessary tools needed at formulating economic policies that will enhance the current drive for sustainable development especially in the sub Saharan African region.

2. Academia

This study examined the impact of financial intermediation on economic development in sub Saharan African Countries. The study of economic development has attracted the attention of economists’ right from Adam Smith to Marx and Keynes. However, most of these studies have reviewed its impact based on developed economies. However, this study primarily is based on underdeveloped countries in the sub Saharan African region; thus, this study will increase literature in this area of finance and economics.

1.8       Philosophical Positioning of the Study

The philosophical position taken by a researcher determines the methodology and hence the method applied. As stated by Saunders and Thornhill (2007), research philosophy can be defined as the development of the research background, research knowledge and its nature and this help the research paradigm. In this study, the definition given by Cohen, Manion and Morrison (2000) that research paradigm broadens the framework, which comprises perception, beliefs and understanding of several theories and practices that are used to conduct a research was insightful. The philosophical basis for this study is ontology (study of reality) with epistemology (study of knowledge) underpinning. However, we adopted the Realism paradigm to explore the impact of financial intermediation on economic development of sub Saharan African countries. Critical realism sees the social world as existing externally and measurable by objective methods. It brings together the natural and human social sciences and so is an integrative epistemology blends structure and agency. It considers that the objects of scientific knowledge exist and act independently of our beliefs about them. These beliefs are always provisional and fallible. It acknowledge the socially and historically constructed form of scientific theories and knowledge claims and assumes scientific method which presupposes independent existence as well as rejects socially constructed character of knowledge (Neuman, 2000).

Augustus Comte was influential in this view and
believed that real knowledge was based upon observed fact (Comte, 1853). Although there is no single universally accepted set of characteristics, taking this view the researcher sees “truth” as logical, linked and predictable and believes it is possible to derive and understand it through objective mathematical logic and scientific methods. Thus, this study used quantitative methods from panel data obtained from the World Bank to derive a model of the impact of financial intermediation on economic development of sub Saharan African countries.

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