On the relationship between financial development and trade openness

Abstract

The aim of this paper is to evaluate the relationship, if any, between trade openness and the financial development in both, developed and developing countries. The relevance ofthe openness of the trade (TO) on the development of financial sector (FD) is explored in three panels. The first overall panel contains 64countries; the second contains 13 developed countries, while the third panel contains 51 developing countries over the period 1995-2016. Models are initially estimated using linear static and dynamic panel data estimators for balanced panel. Since N<T in the case of developed countries, there was a need to use PMG. Moreover, a Granger causality test that implements a vector autoregressive (VAR) framework within the panel setting is employed. Linear static panel data estimators indicate a significant positive impact of TO on FD for the overall sample of countries as well as for developed and developing countries. The findings of linear dynamic panel data estimators indicate a significant positive relationship between economic terms of interest for overall sample of countries as well as for developing. PMG framework reports a significant positive relationship only in the long-run. Granger causality test reveals a reverse causal relationship between trade openness and financial development in overall sample as well as in the case of both, developed and developing countries. Therefore, the overall conclusion states that in order to drive financial development, governments need to foster trade liberalization and to increase trade openness.