Revisiting financial liberalisation and economic growth: A review of international literature

Abstract

In this paper, we review the existing literature on the relationship between financial liberalization and economic growth, highlighting both the theoretical framework and empirical evidence. Our review is different from other reviews; since it critically evaluates the impact of financial liberalization on economic growth regarding its strength, weakness and policy implications. Unlike other previous reviews that tend to focus mainly on the impact of interest-rate liberalization on economic growth, our study incorporates other forms of financial liberalization, such as stock market liberalization and exchange rate liberalization. Based on the literature reviewed in this paper, we have found that the relationship between financial liberalization and economic growth is inconclusive – with some studies showing a positive effect of liberalization policies; while other studies have shown the negative effect of financial liberalization. Whether financial liberalization contributes to more economic growth, as postulated by its proponents, therefore, remains an empirical issue. We also found the efficacy of financial liberalization to be dependent on the proxy used to measure the level of financial liberalization, the country of study, and the methodology used. In addition, we have found that countries that observed the preconditions for financial liberalization ended up with a positive outcome; while countries that hurriedly liberalized their financial sectors had a negative outcome. We, therefore, recommend that full financial liberalization should not be implemented – without a concomitant strong prudential regulation, a stable macroeconomic policy and an impregnable institution in place.