Financial development and economic growth

My paper investigates the finance-growth nexus within the context of Saudi Arabia using annual data for the period from 1970 till 2015. For the financial development index, principle component analysis (PCA) was conducted to generate two indexes for financial development. The first one (PCA1) covers financial development depth and efficiency in the period 1970-2015 while the second one (PCA2) covers financial development depth, efficiency and capital market performance in the period 1985-2015. The remaining variables used in this model are gross domestic product (GDP) per capita for growth, intuitional investors assets and two control variables. This data set was retrieved as row data from both the World Bank's national accounts data and Saudi Arabian monetary authorities (SAMA) 53rd yearly book.

Many econometric test are being conducted to explore the long- and short-term relationships between variables such as vector auto regression (VAR) and vector error correction model (VECM). The results of the Johanson co-integration test illustrate that there is a long-run relationship among the model variables and confirmed that financial development indicators (PCA2) have a statistically significant effect economic growth in the long-run. VECM also shows a significant long-run relationship between financial development and growth. In the short-run, the VAR model revealed that GDP per capital openness. Moreover, the Wald test was used to confirm the VAR model results and revealed the same results. Financial development in Saudi Arabia plays a key role in boosting economic growth and institutional investor's assets was insignificant in both the short-run and long-run. This can be linked to the fact that some of the Saudi Arabian institutional investors are recently established and might affect the results. Further research should examine other factors that influence this relationship and why financial development implication varies from one country to another.