Causality between financial development and economic growth: the cases of Kuwait, Oman, and Saudi Arabia

Abstract

In an attempt to determine what causes economic growth, economists have studied various influences, among them is the role of the financial system in economic growth. Some argue that financial and monetary factors do not have any effect on real variables such as GDP growth. However, a large body of empirical research has found a robust relationship between financial development and economic development. Using two different models and three alternative financial development indicators, this study investigates the short-run and the long-run relationship and causality between financial development and economic growth in Kuwait, Oman, and Saudi Arabia, using OLS estimation, Johansen multivariate cointegration technique, and short-run and long-run Granger causality within the error-correction mechanism (ECM). The results of the OLS regressions reveal that in case of Kuwait the relationship between financial development indicators and economic growth is negative. While in the case of Oman and Saudi Arabia, the results reveal that there is a positive relationship between the financial development indicators and economic growth. The results of the cointegration test reveal that there is a long-run relationship between the financial development indicators and economic growth indicating that the two variables move together in the long-run for all three countries. However, this long-run relationship is negative in the case of Kuwait. The results of the error-correction model suggest that in the case of Kuwait, the causality is, in general, running from economic growth to financial development. While in the case of Oman and Saudi Arabia, the results, in general, suggest that the short-run causality runs from financial development to economic growth, while in the long-run the causality is from economic growth to financial development. In the case of Oman and Saudi Arabia, the results suggest that policies designed to encourage further investments in the financial and banking systems would be beneficial for promoting economic growth. While in the case of Kuwait, the results suggest that some problems exist. One hypothesis is that the financial system in Kuwait seems to be suffering from the regional crises that resulted from the Iraqi invasion of Kuwait in 1990.