n. 542 September 2014

ISSN: 0870-8541

Financial Development and Economic Growth in a

Natural Resource Based Economy: Evidence from

Angola

Yuri Quixina1

Álvaro Almeida1,2

1 FEP-UP, School of Economics and Management, University of Porto2 CEF.UP, Research Center in Economics and Finance, University of Porto

FINANCIAL DEVELOPMENT AND ECONOMIC GROWTH IN A NATURAL

RESOURCE BASED ECONOMY: EVIDENCE FROM ANGOLA

Yuri Quixina

Faculdade de Economia, Universidade do Porto

Álvaro Almeida

CEF.UP and Faculdade de Economia, Universidade do Porto †

September 8, 2014

† Email: almeida@fep.up.pt - Address: Rua Dr. Roberto Frias, 4200-464 Porto. CEF.UP, Centre for

Economics and Finance at University of Porto is supported by the Foundation for Science and

Technology (FCT), Portugal.

ABSTRACT

This paper analyzes the relationship between financial development and economic growth in

Angola, an economy heavily dependent on natural resources. We extend existing literature by

treating separately the oil and non-oil sectors of the economy. We test for Granger causality

between three variables – oil revenues, non-oil GDP and financial development – for the

Angolan economy for the period 1995-2012. The results show that the oil sector has been the

great engine of Angolan economic growth, since we identified Granger causality from oil

revenues to the other two variables, but none of these variables Granger causes oil revenues.

On the other hand, financial development does not seem to have a significant role in economic

growth in Angola: it does not Granger-cause either oil revenues or non-oil GDP, even though

it is Granger-caused by both variables.

Keywords: Financial Development, Economic Growth, Natural Resources, Angola

JEL Classification: E44, O16, O43, Q32

1. INTRODUCTION

The existence (and the direction) of causality between financial development and economic

growth has long been a subject of debate. The basic arguments point to the fact that financial

development may promote economic growth through improved resource allocation efficiency,

but economic growth also leads to increased demand for credit that should support the

development of the financial sector.

Despite numerous studies, the question of cause and effect remains the subject of debate in the

literature (see next section for references). However, most of this literature is based on cross-

section or panel data that mixes information from different countries, with different economic

structures, a feature that could be at the origin of the mixed results.

In particular, the financial sector / economic growth causality is likely to be different in natural

resource-based economies than in non-resource based economies. In an economy largely

dependent on natural resources (for example, oil), it is very unlikely that financial sector

development has a significant influence on overall growth. The growth of the oil sector (and

thus, the growth of the overall economy, if the economy is oil dependent) is mostly determined

by the evolution of external markets for that commodity, and, as such, it is unlikely that the

development of the domestic financial sector has a significant effect on overall growth.

But what about the relation between financial development and the rest of the economy (the

sectors not directly related to oil production)? Does causality from financial development to the

growth of the non-oil sector (or vice-versa) exist? The answer to this question may have

important development policy implications. The growth of the non-oil economy may have a

small impact on the (current) growth of the overall economy due to its small relative size, but

it is the most important from a development perspective, especially in economies based on non-

renewable resources (like oil), since future growth will depend more and more on the non-oil

sector.

The main contribution of this paper is to provide an innovative approach to the financial

development / economic growth debate, using evidence from the Angolan economy. The

majority of the previous work is based mainly on two-variable models, looking at the

relationship between financial development and economic growth. We use a three-variable

model by separating the oil and non-oil sectors of the economy and analyzing the causality

between these two sectors and the financial sector. Specifically, we test for Granger causality

between three variables – oil revenues, non-oil GDP and financial development – for the

Angolan economy for the period 1995-2012. The separation of the oil and non-oil economy

allows for a more complex relationship between financial development and economic growth,

allowing for different causalities between financial development and the oil and non-oil sectors,

and allowing for the identification of the role of the oil economy as an economic driver in

Angola.

The rest of the paper is organized as follows. In section 2 we provide some context on the

Angolan economy and on the literature on the relationship between financial development and

economic growth. In section 3 we present the methodology we used. Section 4 presents the

main results from the estimation of our model, while section 5 is dedicated to the discussion of

these main findings. Section 6 concludes.

2. CONTEXT

In the first decade of the twenty-first century, GDP growth in Angola has been one of the highest

in the world. The main driver of growth in Angola has been the oil sector, which represents

more than 50% of the Angolan economy, fostered by the increase in oil prices during that period

(CEIC, 2013). Furthermore, the importance of oil for the Angolan economy is larger than its

direct value added contribution to GDP, because over 50% of public investments are financed

by oil revenues (CEIC, 2013). During the same period, the financial sector in Angola

transformed from virtually non-existent to one of the largest in Africa, with 6 of the 23 Angolan

banks in the Top 100 of Africa’s largest banks in 2011 (KPMG Angola, 2013).

The importance of natural resources (especially oil, but also diamonds) in the Angolan economy

is widely recognized (see, for instance, International Monetary Fund 2014), but the effects of

abundant natural resources on economic development are not necessarily positive. There may

be a “resource curse”, i.e. a negative correlation between resource abundance and economic

growth, especially in the absence of strong domestic institutions (see, for instance, Frankel

2010, Boyce and Emery 2011, Atkinson and Hamilton 2003). On the other hand,

Brunnschweiler (2008) found a positive direct empirical relationship between natural resource

abundance and economic growth. Agnani and Iza (2011) showed that in oil-dependent

Venezuela economic growth was largely due to the development of non-oil GDP, and the

behavior of the non-oil sector can largely be explained by the evolution of total factor

productivity, which in turn could be influenced by the development of the oil sector. Thus, the

existing literature suggests that economic growth in countries with abundant natural resources

depends on how the effects of the resource-based sectors are transmitted to the non-resource

based sectors.

The financial sector may play an important role linking the resource-based sectors to the non-

resource based sectors, namely by efficiently allocating the surpluses generated in the former

sector to projects in the later sector. The positive effects of financial sector development on

economic and productivity growth have been identified by many authors, such as King and

Levine (1993), Pagano (1993), Levine (1997), Levine et al. (2000), Beck et al. (2000) and

Deidda (2006). Other authors have identified bidirectional causality between financial sector

development and economic growth (Demetriades and Hussein, 1996; Calderón and Liu, 2003;

Fowowe, 2010; Raz, 2013; Rufael, 2009; Ang, 2008; Ang and McKibbin, 2007; Yang and Yi,

2008; Zhang et al., 2012; Ma and Jalil, 2008).

On the other hand, some authors have questioned the existence of causal relationship from

financial development to economic growth (Disbudak, 2010; Ho, 2002; Loayza and Rancière,

2006; Odhiambo, 2008; Odhiambo, 2010). Others found no causality in the short term, but

identified a long run causality between financial deepening and economic growth

(Christopoulos and Tsionas, 2004; Bangake and Eggoh, 2011). Hassan et al. (2011) found

bidirectional causality between financial development and economic growth in most regions,

but found no causality from financial development to economic growth in sub-Saharan Africa.

Overall, the review of existing literature indicates that the debate regarding the importance of

financial sector development for economic growth is still open. This mixed evidence could be

the result of financial factors having a smaller role in economic growth than some economists

expect, as Lucas (1988) considered. Or it could be the result of our limited understanding of

how and why financial development brings about changes in the behavior of agents and the

economic factors that ultimately leads to economic growth (Yang and Yi, 2008; Wachtel,

2003). Odhiambo (2008) claims that previous studies have shown that causality between the

variables may differ from country to country and from time to time, and that, in addition to the

methodology used to examine the link between financial development and economic growth,

the direction of causality is quite sensitive to the choice of variables, and in particular, to the

potential omission of an important third variable that affects both economic growth and

financial development.

In this paper we explore the possibility that the relationship between financial intermediation

and economic growth is more complex than a simple bivariate model can capture, and that it

depends on the specific conditions of each country. In particular, we explore the role of the oil

sector in the Angolan economy in a three variable model that allows for different relations

between the financial sector and the oil and non-oil sector.

3. METHODOLOGY

In order to analyze the relation between financial development and economic growth in Angola,

during the period 1995-2012, we test for Granger causality between three variables: financial

development, oil revenues and non-oil GDP.

Financial development is measured by the ratio of monetary aggregate M2 to GDP, following

Outreville (1999) that considers this the most adequate measure of financial development and

deepening. The growth of the oil sector is measured by oil rents per capita, while the growth of

the non-oil economy is measured by the variable real non-oil GDP per capita, defined as the

difference between total GDP and oil rents. All variables are in constant 2005 US dollars, and

data were obtained from the World Bank: World Development Indicators database.

Following Odhiambo (2008) and Raz (2013), we used the following three variable model to

test for Granger causality between financial development and economic growth in Angola:

(1) 𝐺𝐷𝑃𝐶𝑛𝑝𝑡 = 𝛿0 + ∑ 𝛿1𝑖

𝑛

𝑖=1

𝐺𝐷𝑃𝐶𝑛𝑝𝑡−𝑖 + ∑ 𝛿2𝑖𝑀2

𝑛

𝑖=1

/𝐺𝐷𝑃𝑡−𝑖 + ∑ 𝛿3𝑖𝑂𝑅𝑡−𝑖

𝑛

𝑖=1

+ 𝜇𝑡

(2) 𝑀2/𝐺𝐷𝑃𝑡 = 𝛽0 + ∑ 𝛽1𝑖

𝑛

𝑖=1

𝐺𝐷𝑃𝐶𝑛𝑝𝑡−𝑖 + ∑ 𝛽2𝑖𝑀2

𝑛

𝑖=1

/𝐺𝐷𝑃𝑡−𝑖 + ∑ 𝛽3𝑖𝑂𝑅𝑡−𝑖

𝑛

𝑖=1

+ 휀𝑡

(3) 𝑂𝑅𝑡 = 𝛾0 + ∑ 𝛾1𝑖

𝑛

𝑖=1

𝐺𝐷𝑃𝐶𝑛𝑝𝑡−𝑖 + ∑ 𝛾2𝑖𝑀2

𝑛

𝑖=1

/𝑃𝐼𝐵𝑡−𝑖 + ∑ 𝛾3𝑖𝑂𝑅𝑡−𝑖

𝑛

𝑖=1

+ 𝜈𝑡

Where:

𝑀2/𝐺𝐷𝑃𝑡 = Ratio of monetary aggregate M2 to GDP in year t.

𝐺𝐷𝑃𝐶𝑛𝑝𝑡 = Non-oil GDP per capita in year t.

𝑂𝑅𝑡= Oil rents in year t.

𝜇𝑡, 휀𝑡 and 𝜈𝑡 = mutually uncorrelated white noise residuals.

Before performing the causality test, we examine the stationarity of each time series testing for

the presence of a unit root, using the augmented Dickey-Fuller (ADF) test, with a significance

level of 5%, following MacKinnon (1996).

4. RESULTS

Table 1 presents the results of the ADF tests. The null hypothesis of existence of a unit root is

not rejected for the three variables, implying that the time series of each variable is non-

stationary in levels. However, the null hypothesis of an unit root is rejected for the variables in

first differences, meaning that all variables are I(1), integrated of order one.

Table 1: Results of the ADF test

Variables Levels First differences

M2/GDP -2.6146 -4.3436 *

GDPCnp -2.2791 -5.2634 *

OR -2.5691 -4.9237 *

Notes: The table presents value of the ADF test statistic for each variable. The number of

lags was selected using the Schwarz Information Criterion. The critical value at a 5%

level is -3.7105 for the variables in levels and -3.7332 for the variables in first differences.

* indicates that the null hypothesis is rejected.

Table 2: Granger causality test results

Causality F- Statistic Probability

M2/GDP→ GDPCnp 2.4644 0.1305

GDPC np→ M2/GDP 7.0541 0.0107

M2/GDP → OR 0.5333 0.6011

OR → M2/GDP 13.5568 0.0011

GDPC np→ OR 3.7159 0.0585

OR → GDPCnp 5.7979 0.0191

Table 2 presents the results of the Granger causality for the variables in first differences. Using

a 5% significance level, one can reject the null hypotheses that oil revenues (OR) does not

Granger cause both non-oil GDP (GDPCnp) or M2/GDP and that non-oil GDP Granger causes

M2/GDP. However, we cannot reject the null hypotheses that M2/GDP does not Granger cause

both non-oil GDP or oil revenues and that non-oil GDP Granger causes OR.

5. DISCUSSION

The results of the Granger causality tests confirm that the oil sector has been the great engine

of Angolan economic growth, since we identified Granger causality from oil revenues to the

other two variables, but none of these variables Granger-causes oil revenues. On the other hand,

financial development does not seem to have a significant role in economic growth in Angola.

M2/GDP does not Granger-cause either oil revenues or non-oil GDP, even though M2/GDP is

Granger-caused by both variables. The relationship between financial development and oil

revenues was expected, since the oil sector dynamics are mostly exogenously determined, and

should have a strong impact on the demand for financial services. However, given the evidence

reviewed on section 2 on the positive effects of financial sector development on economic

growth, one might expect to find Granger-causality from financial development to non-oil

growth, which we did not find (although we did find strong causality in the opposite direction).

The results indicate that the development of the banking sector in Angola was demand-

following instead of supply-leading, in the terminology of Patrick (1966). The creation of new

banks and the growth of existing institutions were a response to increased demand for these

services by investors and savers in the real economy, i.e. economic growth caused the

development of financial intermediation (demand following). It seems that the supply-leading

effect, when the creation of financial institutions and the provision of its services creates

opportunities for savers and investors and thereby boosts economic growth, was not significant

in Angola.

This result is in line with Hassan et al. (2011), who found that in sub-Saharan countries with

low savings and underdeveloped financial systems, financial development does not cause

economic growth, but the reverse causality is strong, to the extent that countries are highly

specialized in the export of raw materials.

In short, the performance of the oil sector was the key to a strong economic growth of the

Angolan economy in the period and this in turn greatly stimulated the development of the

banking system.

6. CONCLUSION

In this paper, we revisited the relationship between financial development and economic growth

by allowing for differences in the relationship of the financial sector with the oil sector and the

non-oil sector. We tested for Granger-causality in a three variable model including the ratio of

M2 to GDP, oil revenues and non-oil GDP per capita, using data for Angola for the period

1995-2012.

Our results show that in the Granger sense, the development of the banking system did not

cause economic growth in Angola, both for the oil and non-oil sectors. However, economic

growth (both oil and non-oil) caused the development of the banking system. These results

suggest that any argument that financial development unambiguously leads to economic growth

should be treated with extreme caution.

The lack of impact of financial development on the non-oil sector is surprising, given the

positive effects found in other countries. This result suggests that Angola’s financial sector may

be underdeveloped, and that the implementation of policies that foster the efficiency of the

financial sector could provide a boost to growth in the non-oil sector.

REFERENCES

Agnani, B. and Iza, A. (2011), “Growth in an oil abundant economy: the case of Venezuela”,

Journal of Applied Economics. Vol. XIV (1), pp. 61-79.

Ang, J. (2008), “What are the mechanisms linking financial development and economic growth

in Malaysia?” Economic Modelling 25, pp. 38–53.

Ang, J. and McKibbin, W. (2007), “Financial liberalization, financial sector development and

growth: Evidence from Malaysia”, Journal of Development Economics 84, pp. 215–233.

Atkinson, G. and Hamilton, K. (2003), “Savings, growth and the resource curse hypothesis”,

World Development, Vol. 31 (11), pp. 1793–1807.

Bangake, C. and Eggoh, J. (2011), “Further evidence on finance-growth causality: A panel data

analysis”, Economic Systems 35 (2), pp. 176-188.

Beck, T., Levine, R. and Loayza, N. (2000), “Finance and the Sources of Growth”, Journal of

Financial Economics 58, pp. 261-300.

Boyce, J. and Emery, J.C. (2011). “Is a negative correlation between resource abundance and

growth sufficient evidence that there is a‘‘resource curse’’?”, Resources Policy 36, pp. 1–13.

Brunnschweiler, C. N. (2008), “Cursing the Blessings? Natural Resource Abundance,

Institutions, and Economic Growth”, World Development 36 (3), pp. 399–419.

Calderón, C. and Liu, L. (2003), “The direction of causality between financial development and

economic growth”, Journal of Development Economics 72(1), pp. 321-334.

CEIC/UCAN (2013), Relatório Económico de Angola 2012, Universidade Católica de Angola.

Christopoulos, D. and Tsionas, E. (2004), “Financial development and economic growth:

evidence from panel unit root and cointegration tests”, Journal of Development Economics 73,

pp. 55 – 74.

Deidda, L. (2006), “Interaction between economic and financial development”, Journal of

Monetary Economics 53, pp. 233–248.

Demetriades, P. and Hussein, K. (1996), “Does financial development cause economic growth?

Time–series evidence from 16 countries”, Journal of Development Economic 51, pp. 387-411.

Disbudak, C. (2010), “Analyzing the bank credit-economic growth nexus in Turkey”, European

Journal of Economics, Finance and Administrative Sciences, (23), pp. 34-48.

Fowowe, B. (2010), “The finance-growth nexus in Sub-Saharan Africa: panel cointegration and

causality tests”, Journal of International Development, 23, pp. 220–239.

Frankel, J. (2010) “The Natural Resource curse: A survey”. NBER Working Paper No. 15836.

(http://www.hks.harvard.edu/fs/jfrankel/NatResCurseNBERwp15836.pdf), accessed on April

20, 2014.

Hassan, M., Sanchez, B. and Yu, J. (2011) “Financial development and economic growth: New

evidence from panel data”, The Quarterly Review of Economics and Finance, 51(1), pp.88-104.

Ho, N.W. (2002), “Financial development and economic growth in Macau”, AMCM Quarterly

Bulletin, 3, pp. 15-30.

International Monetary Fund (2014), “Angola: Second Post-Program Monitoring”, IMF

Country Report No. 14/81, March 2014.

King, R. and Levine, R. (1993), “Finance and Growth: Schumpeter Might be Right”, Quarterly

Journal of Economics, 108(3), pp. 717-737.

KPMG Angola (2013), “Análise ao sector bancário Angolano” (available at

http://www.kpmg.com/pt/en/kpmgangola/pages/default.aspx, accessed on October 3, 2013).

Levine, R. (1997), “Financial development and economic growth: views and agenda”, Journal

of Economic Literature, 35(2), pp. 688-726.

Levine, R., Loayza, N., e Beck, T. (2000), “Financial intermediation and growth: Causality and

causes”, Journal of Monetary Economics, 46(1), 31-77.

Loayza, N., and Ranciere, R. (2006), “Financial development, financial fragility, and growth”,

Journal of Money, Credit and Banking, 38(4), pp.1051-1076.

Lucas Jr., R. E. (1988), “On the mechanics of economic development”, Journal of Monetary

Economics, 22, pp. 3-42.

Ma, Y., and Jalil, A. (2008), “Financial Development, Economic Growth and Adaptive

Efficiency: A Comparison between China and Pakistan”, China & World Economy / 97 – 111,

Vol. 16, No. 6, 2008.

MacKinnon, J. G. (1996). Numerical distribution functions for unit root and cointegration tests.

Journal of Applied Econometrics, 11(6), 601-618.

Odhiambo, M. (2008), “Finance depth, savings and economic growth in Kenya: A dynamic

causal linkage”, Economic Modelling 25, pp. 704-713.

Odhiambo, M. (2010), “Finance-investment-growth nexus in South Africa: an ARDL-bounds

testing procedure”, Econ Change Restruct, 43, pp.205–219.

Outreville, J. François (1999), Financial Development, Human Capital and Political Stability,

United Nations Conference on Development (UNCTAD), Palais des Nations, CH-1211 Geneva

10, Switzerland, No 142.

Pagano, M. (1993), “Financial markets and growth: An overview”, European Economic

Review, 37, pp. 613-622.

Patrick, Hugh. T. (1966) "Financial Development and Economic Growth in Underdeveloped

Countries". Economic Development and Cultural Change, vol. 14, n° 2, pp. 174-177.

Raz, A. (2013), “The nexus between bank credit development and economic growth in

Indonesia”, DLSU Business & Economics Review 23, pp. 93-104.

Rufael, Y. (2009), “Re-examining the financial development and economic growth nexus in

Kenya”, Economic Modelling 26, pp. 1140–1146.

Wachtel, P. (2003), How much do we really know about growth and finance? Federal Reserve

Bank of Atlanta Economic Review, 33–47.

Yang, Y. and Yi, M. (2008), “Does financial development cause economic growth? Implication

for policy in Korea”, Journal of Policy Modeling 30, pp. 827–840.

Zhang, J., Wang, L., and Wang, S. (2012), “Financial development and economic growth:

Recent evidence from China”, Journal of Comparative Economics 40, pp. 393–412.

Editorial Board (wps@fep.up.pt)Download available at: http://wps.fep.up.pt/wplist.php

also in http://ideas.repec.org/PaperSeries.html

15