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«Financial Development, Trade Openness and Economic Growth: Evidence from Sultanate of Oman (1972-2012) (Prof.) Dr. Hatem Hatef Abdulkadhim Altaee 1 ...»

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Journal of Economics and Sustainable Development www.iiste.org

ISSN 2222-1700 (Paper) ISSN 2222-2855 (Online)

Vol.5, No.23, 2014

Financial Development, Trade Openness and Economic Growth:

Evidence from Sultanate of Oman (1972-2012)

(Prof.) Dr. Hatem Hatef Abdulkadhim Altaee 1 Dr. Sabah Mahmood Saied2 Dr. Ezat Sabir Esmaeel2


Mustafa Hassan Mohammad Adam, Ph.D

1. Department of Accounting, Cihan University Sulaimaniyah–Kurdistan Region, Iraq

2.Department of Economics, University of Sulaimaniyah, Kurdistan Region, Iraq.

3.Department of Accounting, Komar University of Science & Technology, Sulaimaniyah–Kurdistan Region.

*E-mail of corresponding author: koosaye@yahoo.com Abstract There is a huge debate on the impact of financial development and trade openness on the economic growth.

Accordingly, this study investigated the role of financial development, trade openness on economic growth in a small and open country i.e., Sultanate of Oman during the period 1972-2012. We apply the recently developed econometric techniques: namely the unit root tests for stationarity, Johansen and Juselius (JJ) for cointegration in VAR framework and Granger causality test for causal relationships in addition, variance decomposition analyses (VDC) based on VAR results is computed in order to address the question of causality between trade openness, financial development and economic growth beyond the selected time span. The Granger causality test indicates unidirectional causality from economic growth to financial development, while empirical results derived from VDCs show that trade openness shock is the most important source of shock to GDP and financial development.

Indicating unidirectional causality running from trade openness to the other two series. Shock to trade openness is important sources of variability for its own at first, but this self-effect diminishes in a very small portion. Our finding indicates that economic policies aimed at trade openness have a statistically significant impact on financial development and economic growth.

Keywords: Financial Development, Trade Openness, Economic Growth, VAR, Variance Decomposition, Impulse Response Function, Sultanate of Oman

1. Introduction Link between trade openness and economic growth, and financial development and economic growth are the subject of an enormous number of both theoretical and empirical literatures. The conventional wisdom is that strong link between financial markets development and trade openness opens up a further channel by which financial systems and real sectors may interact in more efficient way. Advanced and smoothly financial systems may constitute a comparative advantage for real sectors that heavily rely on external financing (Kletzer and Bardhan, (1987); Beck, (2003). On the other hand, trade openness has been considered one of the main contributors to economic growth. Export expansion can increase productivity, offering greater economies of scale. Exports are likely to alleviate foreign exchange constraints and can thereby provide greater access to global markets. As argued by Melina et al (2004); and Svaleryd and Vlachos (2002). Financial markets help to efficiently direct the flow of savings and investment in the economy in ways that enhance the physical and human capital accumulation and the production. Therefore, well-developed, and better operating financial markets play an important role in achieving economic efficiency. By contrast, developing countries, with poorly developed financial markets, instruments, and financial institutions, find their effort to raise capital is more costly and may lower the return on savings or investments and the production of goods and services Demirgüç and Levine (2001). According to Do and Levchenko (2004) openness to trade will affect demand for external finance, and thus financial depth, in the trading countries. In richer countries, trade should be associated with faster financial development. Edwards & Lederman (1989) find that countries that liberalize their international trade and become more open will tend to grow faster, especially in the developing world. Moreover, in the developing countries the opening of goods and service markets seems to be a precondition for financial development. In turn, financial development allows developing countries to encourage the country’s trade openness.

1.1 Importance of the Study The above debate confirms the strong relationship between trade openness, financial development and economic growth. The objective of this study empirically investigates the possible co-integration and the causal link between financial development, trade openness and economic growth in Sultanate of Oman by using time series data from 1972 to 2012. This research adds three main contributions to the on-going literature on growth, trade and finance: (i) It studies the collective impact of trade openness and financial development on economic growth in Oman. (ii) It employs recent econometric techniques of causality in VAR framework as well as variance decomposition analysis. And, (iii) It uses an updated and relatively long set of data and an alternative measure to Journal of Economics and Sustainable Development www.iiste.org ISSN 2222-1700 (Paper) ISSN 2222-2855 (Online) Vol.5, No.23, 2014

the commonly used measure of financial development.

1.2 Objectives of Study

The main objectives of this study are to:

(i) find the relationship between financial development, trade openness and economic growth in Sultanate of Oman during the period 1972-2012.

(ii) add to the existing literature of financial development, trade openness and economic growth.

(iii) highlight the economic growth of Sultanate of Oman as an oil exporting country.

1.3 Hypothesis of the Study In order to achieve our aim we can make the following hypotheses.

H1: Financial development increases and causes the economic growth.

H2: Trade openness has positive relation with gross domestic product in long run.

H3: Financial development has negative relation with trade openness The remainder of this paper is organized as follows. Section two presents statement of the problem and rationale of the study, while the third section gives a brief overview of Omani’s economy, while Section four presents a summary of empirical literature on the subject. Sections five describe our empirical methodology and data sources. The results are presented in Section six; and Concluding remarks follow in Section seven.

2 Statement of the Problem and Rationale of the study Trade liberalization is often considered as a significant tool for increasing economic growth in the world economies. Exports of those countries have greatly liberalized their economies, and consequently these countries have also experienced the fastest growth of GDP. Since the relationship between trade liberalization and economic growth has extensively been analyzed in the world, it remained controversial among policy makers and economists based on empirical findings (Chaudhry and Imran, 2009). Many questions were raised about the relationship between trade and growth in developing countries (Kruger, 1997). However, there is a great consensus that trade policy openness and higher ratios of trade volume to GDP were positively related with economic growth. Many developing countries are liberalizing their economies to become attractive destination for foreign capital inflows. Openness of trade regime can increase the investment and efficiency of investment and also can increase the market size in these countries. There has been extensive research studies done on the topic of financial development and economic growth since the start of 20th century. Most of the research works revealed the significance of financial development for the economic growth of the countries all over the world.

Some of the contemporary research conducted on the various regions advocates that the financial depth can induce economic growth and benefits. Although many studies have focused the developing countries to explore relationships between growth and financial development but there are very few studies available with respect to the Oil based nations of Middle Eastern region. (Najeeb and Nasir 2014).

Therefore, Sultanate of Oman as most of other developing countries has liberalized its trade and financial sectors in order to achieve high rate of economic growth. The main argument for this policy is that both trade and financial liberalization policies increase efficiency in the production process and positively influence economic growth. This specific research is conducted in the distinctive settings of Sultanate of Oman, an economy with high oil dependency and strong financial regulations. The national income in the country also fluctuates with the change in oil prices overtime, so it is interesting to see the tri-variate relationship in such a setup with unique characteristics. Many studies determined the dynamic relationship of financial development, trade openness (globalization) and economic growth by using the concept of Granger causality to determine its direction as well as the Toda and Yamamoto method to test for Granger.

2. Oman Economy – overview Oman’s real GDP expanded steadily over the past four decades, with an estimated growth rate of 5.9 percent during the period 1970- 2012. According to the figures reported in table 1,in real terms, Oman’s GDP grew by 8.4%, up from the 6.4% in the second period. The highest growth rate was reached during the period 1980-1990.

As illustrated in Chart 1, GDP in Oman decreased sharply from the period 1980-1990 to 1990-2000, from a growth rate of 8.4% to 4.4%. This is a consequence of the global crisis which has a notable impact on most of the GCC.

–  –  –

22.5% 22.0%70 75 80 85 90 95 00 05 10 A sustained growth process in Oman was a manifestation of an improved diversification of the economy, since 2001, reflected in terms of increase in the contribution of non-oil sectors to GDP growth. Oman has liberalized and extensively deregulated foreign trade. After accession to the WTO in 2000, the government encouraged foreign trade and investment and introduced industrial regulations and labor laws. In order to attract more foreign investment, the new tax system, which came into force in January 2010, removed the differences between domestic and foreign companies by establishing a fixed tax rate on profits Nadira, (2006). The Omani financial sector, supervised by the Central Bank of Oman (CBO), which was established in 1974, has transformed substantially in recent years. The Muscat Securities Market (MSM) was established in 1989. During the period under consideration, an influential new chapter in Omani banking history came in May 2011 with a royal decree approving the establishment of Islamic banks BTI Oman Country Report (2014).

3 Literature Review The relationship between financial development, globalization and economic growth is an important matter of discussion in economic literature. And, therefore, the relationship between trade openness and financial development has been a subject matter for a substantial body of empirical work. Their nexus is usually investigated in the empirical literature in two different lines: The first line of the existing empirical research attempt to separately examine the importance of trade openness or financial development on economic growth.

The second line of the empirical works examines the relationship between trade openness and the financial development collectively. With regard to methods haven used to determine the importance of financial development and/or trade openness to economic growth, there are two main methods. The first one employs simple or multiple regressions, while the second method employs the causality technique. Recently, most of studies have attended to focus on VAR and VEC models and cointegration approach. Our review of literature is limited to studies that focus on the joint impact of both variables on economic growth.

Islam, et al., (2014) implement the autoregressive distributed lag (ARDL) bounds testing, supplemented by the Johansen-Juselius (JJ) approaches to cointegration to explore a long-run relationship among energy use, economic growth, financial development, capital, and trade openness in Australia. They also apply the vector error correction model (VECM) to understand the short-run dynamics. The study covers the period, from 1965 till 2009, and is hallmarked by major shocks across the globe which can potentially cause structural break in the series. The Granger causality test shows bidirectional causality between energy consumption and economic growth; financial development and energy consumption. Similarly, Yazdi and Shakouri (2014) examine the long-run cointegrating and short-run dynamic relationship among carbon emissions, energy consumption, economic growth, urbanization, financial development and openness to trade in Iran by using Auto Regressive Journal of Economics and Sustainable Development www.iiste.org ISSN 2222-1700 (Paper) ISSN 2222-2855 (Online) Vol.5, No.23, 2014 Distributed Lag (ARDL) testing approach of cointegration. The direction of causal relationship between the series is examined by VECM Granger causality approach. Empirical results for Iran over the period between 1975 and 2011 suggest an evidence of a long-run relationship between the variables in Iran.

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