Project Materials

AN EVALUATION OF FINANCIAL DEVELOPMENT AND ECONOMIC GROWTH: EMPIRICAL EVIDENCE FROM NIGERIA

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Over the last two decades, both theoretical and applied research has focused on the causes of economic growth. However, the mechanism underpinning economic performance is insufficiently conceptualised and poorly understood, which can be attributed in part to the lack of a generalised or unifying theory, as well as the myopic approach taken by conventional economists (Artelaris et al, 2007).

Economic growth in a developing economy is dependent on an effective financial system that pools local savings and mobilises foreign capital for productive investment.

Industries in developing nations require additional capital to enhance their investment in order to satisfy the constraints of globalisation.

According to Hicks (1969), in the nineteenth century, many private investment projects were too large to be financed by individuals or retained projects.

The stock market then plays a vital role in mobilising and allocating savings among competing purposes that are critical to the economy’s growth and efficiency (Alile, 1984).

Recent theoretical research on financial development and economic growth suggests three essential routes through which capital markets, other financial markets, and economic growth may be linked (Pagano, 1993).

First, capital market development raises the share of savings directed towards investments; second, capital market development may vary the savings rate, so affecting investments; and third, capital market development improves capital allocation efficiency.

It is widely acknowledged that the stock market and other financial market institutions play an important role in the economy by increasing the efficiency of capital formation and allocation.

They enable both firms and governments to raise long-term and short-term capital, allowing them to finance new projects and expand other operations.

It has been noted that when capital is delivered to productive economic units, the economy’s performance improves. Furthermore, as economies develop, additional funds are required to meet the rapid expansion, and the stock market serves as an appropriate avenue for resource mobilisation and allocation among competing uses that are critical to the economy’s growth and efficiency.

In another study, Alile (1997) suggested that the overall growth of an economy is determined by how well the stock market fulfils its allocative capital tasks.

Stock markets are an important component of economic development because they provide a platform for listed companies to generate long-term capital and a place for investors to spend their surplus assets.

As economies develop, more funds are required to match the rapid expansion, and stock markets and banks play a vital role in mobilising and allocating savings among competing purposes that are critical to the economy’s growth and efficiency.

Stock markets drive economic growth by diversifying, mobilising, and pooling savings from various investors and making them available to businesses for maximum utilisation.

The causal association between financial development, with a focus on the stock market, banks, and economic growth, has sparked disagreement in academic circles, and the controversy stems from the fact that the relationship between the two variables is dynamic in nature.

Theoretical literature has produced conflicting predictions about the role of financial development in economic growth. Schumpeter (1911), Gurley and Shaw (1955), Goldsmith (1969), McKinnon (1973), and Shaw (1973) all contend that financial repression in the Less Developed Countries (LDCs) slows economic growth.

The causal relationship between economic growth and financial development is a contentious topic. Essentially, the dispute has revolved around whether financial development precedes economic growth or economic growth follows financial development.

Another viewpoint, that the link is dynamic, complicates this “financial development economic growth puzzle”. The majority of related research conducted over the last three decades has focused on the role of financial development in encouraging economic growth, and while much work has been cross-country, none has recently focused explicitly on Nigeria.