The relationship between financial development and economic growth has been researched and developed over the years to try to determine its validity. The theory that financial growth facilitates economic growth can be proved by considering the effects of business transactions and channeling of transactions through the economy, factors that lead to the growth of economic indicators in the country. Economic development is measured by factors like the Gross Domestic Product (GDP) and the National Domestic Product (NDP), both of which indicate the level of growth that a country has developed.
There exists a common consensus that the role of financial intermediaries is important in the determination of the economic growth of a country. Thus, this paper will focus on the financial development of Nicaragua to determine whether it is a factor in the economic development of the country. This paper will use empirical data from the country to determine the link between the economic growth and financial development, and thus prove the theory proposed by Goldsmith that the economic growth of a country is largely affected by its financial development. The selection of this economy for the purpose of this paper is based on the availability of empirical data and the relative ease of assessment of this data. The next section of the paper will focus on the literature review, theoretical background of the study, the third section will focus on the methodology, and data analysis and the last section will conclude the paper.
Literature Review and Theoretical Background
There have been many studies exploring the relationship between the financial development of a country and the subsequent economic growth. The literatures reviewed in this section are empirical tests conducted in different countries and served as an introduction to the issue of financial growth and economic development in Nicaragua.
The studies of whether financial development is a positive factor in the economic development of a country are not limited to the issues affecting economic growth; some studies have tried to analyze the different factors of financial development that affect the economic growth of the country. There are two main types of financial structures available to a country, bank-based or market-based financial systems, therefore, the issue of which factor promotes economic development has to be completely reviewed. Bank-bases financial systems help to maintain the financial development of Nicaragua by providing avenues of resource mobilization, risk management, information acquisition, and thus influence economic growth in the end. However, market based financial systems also promote economic growth by providing alternative systems of mobilizing liquid assets. This is mainly done by the provision of easy-to-access stock and security markets, both of which are utilized by the country to manage financial growth. The diversification offered by the market-based system of financial management also helps in the long run economic growth of Nicaragua.
Methodology and Data Analysis
The main source of the empirical data used for this part of the study was acquired from the World Bank’s World Development Indicators, data that represent the financial and economic growth of Nicaragua for the years 1999-2010. Therefore, the model used is simplified, and the data revised to fit the model of one country in contrast to 20 countries.
The main economic indicators that this study utilizes are the real per capita gross domestic product, which was estimated by dividing the gross domestic product by the population of the country. The Gross Domestic Product for Nicaragua as of 2010 was $6,551,182,431, the population stood at 5,788,163 productive people, and the GNI per capita stood at $1,090. These economic indicators can be attributed the financial stability of the intermediaries present in the county, with the dependent variable for the study being the economic growth measured by the GDP and GNI.
An analysis of the model presented by the financial data above indicates that the GDP growth is due to the financial growth. This is arrived at after considering the value of credit extended by the financial intermediaries to the private sector divided by the GDP. Higher levels of this factor indicate that the financial development of the financial intermediaries leads to the development of the economy of the country.
As an empirical analysis of the data presented above, an intersectoral analysis of the results indicates that there is a positive correlation between the financial development of Nicaragua and the economic growth of the country. This is a positive confirmation of the model proposed by Goldsmith, that there is a perfectly positive correlation between the economic growth of a country and the associated financial development. The role of financial liberalization on the economic growth of a country cannot be denied, because the data for Nicaragua indicates the country’s economic growth is majorly dependent on the development of financial intermediaries present in the country.
The objective of this study is to estimate the relationship between the financial growth and the economic development of Nicaragua, and as the data indicates, the model proposed by Goldsmith is true. This means that the financial development of a country and the economic growth of the said country are perfectly correlated, which indicates that the financial intermediaries present in the country should be developed. The analysis of the data presented in this paper and the literature reviewed all support this conclusion, and indication that the economic indicators are in direct relation to the financial stability of the country. The role of the banking and the market sectors should be enhanced in Nicaragua to reflect the role of economic indicators defined in the country. This is because, as indicated by this study, financial intermediaries help in the economic development of the country regardless of whether the country focuses on a bank-based or market-based financial structure. From the literature review, it is evident that the choice of financial structure does not affect the economic growth evidenced by the economic indicators.