The relationship between financial system development and economic growth in the egyptian economy

Over the recent decades, there have been extensive theoretical and empirical debates on the relationship between finance and growth. However, the empirical results are ambiguous and vary according to the measures of financial development; function form; estimation method; and data frequency. Therefore, by using different time series techniques, this thesis investigated three different aspects but, nevertheless, interrelated dimensions of the finance-growth nexus in developing countries and, particularly, in the case of Egypt. Firstly, by using a Vector Error Correction Model (VECM) in which the banking sector and the stock market were modelled explicitly and simultaneously, we investigated the relationship and causality direction between financial development and
economic growth. The co-integrating vector showed that, rather than the banking sector, stock market development was more conducive to a higher rate of growth. Moreover,
the causality pattern showed that, whilst, in the long-run, there was a consistent causality pattern which supported the demand-following view, in the short-run, the
causality pattern provided mixed results. Secondly, based on McKinnon’s complementary hypothesis, we investigated the long-run and short-run association between financial liberalisation; financial development; interest rate behaviour; and savings and investment. On the one hand, the empirical findings indicated that McKinnon’s complementary hypothesis did not hold in the case of Egypt and, on the
other hand, financial development led to larger financial systems which contributed positively to savings; investment; and economic growth. However, financial
liberalisation had an adverse effect on savings and investment.
Finally, we evaluated the validity of the new structuralism hypothesis highlighting a dynamic relationship between country’s financial structure and the phase of economic
development. The main findings confirmed the new structuralism hypothesis. Financial structure is dynamic and determined endogenously by the demands from the real
economy for specific types of financial services. Consequently, particular types of financial system structures exist and are more effective than others in managing particular types of risk; matching savings with investment; promoting efficient allocation of resources; and spurring economic growth at particular points of time and stages of economic development. In the early stages of economic development, both the banks and the stock market are important. However, as the economic development advances, the stock market’s importance, relative to banking system, becomes more significant. Accordingly, the primary policy implication is that future financial policies
should strengthen the legal and institutional environment. This would enhance operational efficiency in the financial system and the allocation of capital resources. On the other hand, Policy-makers should encourage economic policies that repress the demand for money and speculation activities. In turn, these would spur investment and
the rate of economic growth. Furthermore, when designing the appropriate financial policy, policy-makers should take into consideration the level of economic development and the structure of the real economy since certain types of financial institutions and arrangements are better than others in serving particular industries.