Does financial development cause economic growth in the ASEAN-4 Countries?

This paper empirically examines the short- and long-run finance-growth nexus during the post-1997 financial crisis in the ASEAN-4 countries (i.e., Indonesia, Malaysia, Thailand and the Philippines) by employing battery of times series techniques such as the autoregressive distributed lag (ARDL) model, the vector error correction model (VECM), the variance decompositions (VDCs) and impulse-response functions (IRFs). Based on the ARDL model, the study documents a long-run equilibrium between economic growth, finance depth, share of investment and inflation. The study also finds that the common sources of economic progress/regress among countries are price stability and financial development. Granger causality tests based on the VECM further reveals that there is: (i) no causality between finance and growth in Indonesia, which confirms “the independent hypothesis” of Lucas (1988); (ii) a unidirectional causality running from finance to growth in Malaysia, thus supporting the “finance-growth led hypothesis” or the “supply-leading view”; (iii) a bidirectional causality between finance and growth in Thailand, in accord with the “feedback hypothesis” or the “bidirectional causality view”; and (iv) a unidirectional causality stemming from growth to finance in the Philippines, the finding echoing the “growth-led finance hypothesis” or the Robinson’s (1952) “demand-following view”. Based on VDCs and IRFs, the study discovers that the variations in the economic growth rely very much on its own innovations. If policy makers want to promote growth in the ASEAN-4 countries, priority should be given to long run policies, i.e., to the enhancement of existing financial institutions in the banking sector as well as the stock market.