Effects of financial sector development on economic growth in Liberia (1960-2008).

Abstract

This study examines the effects of financial sector development on economic growth in Liberia using time series data from 1960-2008. The study investigates empirically the effect of financial sector development on economic growth in Liberia using the Johansen cointegration and the error correction modeling (ECM) techniques. The aim of the study is to find out whether there exists a long-run relationship between growth and financial sector development. The Johansen cointegration procedure validated the existence of a long-run relationship between economic growth and financial sector development.

The Results reveal a positive relationship between financial sector development and economic growth with the direction of causation running from economic growth to financial sector development, a finding which ascribes to the demand following finance hypothesis. Credit to the Private Sector (CPS) which was used as a proxy for financial was found to be statistically significant in explaining growth at current period. However, the third and fourth lagged values of credit to the private sector were found to be statistically significant at ten percent levels but wrongly signed which suggests the presence of financial repression.

Gross Fixed Capital Formation (GFCF) which was used as a proxy for capital stock was found to be correctly signed but statistically insignificant in explaining growth. This was possibly due to the state of technology and capital equipment involved in the production process.

Exports to a large extend was fond to be correctly (positively) signed and statistically significant in explaining growth. Current Labor force was found to be positively signed and statistically significant in explaining the growth process. This implies that the unemployment rate was low. However, in previous years labor force was found to be statistically significant in explaining growth but with a negative signed. The negative signed suggests that in the case of Liberia, the unemployment rate was high. The coefficient of the ECM term is -0.239052 and statistically significant at the 10 percent level which implies that the speed of adjustment is slow. The finding shows that 24 percent of the previous disequilibria, in economic growth were corrected in the current period.

It is recommended that the government in its national reform agenda should seek to include financial policy whose basic objectives from economic growth would be to encourage competition within the financial sector as well as develop a strong transparent institutional and legal framework where enforcement of financial contract and collection of debt will be enhanced.

The exports oriented sector should be strengthened in capacity building to boost exports revenue since increase in exports earnings will boost the import capacity of Liberia where capital goods will be bought with less difficult. Also, Manpower development and institutional capacity building should be a priority of government given the significance of Labor force to economic growth.