Insurance development and the finance-growth nexus: Evidence from 34 OECD countries

https://doi.org/10.1016/j.mulfin.2015.02.001Get rights and content

Highlights

  • We utilize data relating to 34 OECD countries between 1988 and 2012.

  • We use a number of variables to characterize insurance market development (IMD).

  • We examine the link across IMD, economic growth (GDP), and financial development (FID).

  • We show there is a long-run equilibrium relationship between IMD, GDP, and FID.

  • IMD and FID appear to be long-run causative factors for GDP.

Abstract

This paper examines causal relationships between insurance market development, financial development, and economic growth in 34 OECD countries for the period 1988–2012. Insurance market development is defined in terms of life, non-life, and total insurance pervasiveness, both by density and penetration. Financial development is a composite index constructed from eight financial development indicators relating to banking and stock markets. We use a panel vector auto-regression model to reveal the nature of Granger causality among the variables. Our results reveal that insurance market development specifically and financial market development overall seem both to be long-run causative factors of economic growth. On the other hand, our short-run causality results show a diverse pattern of short-run adjustment dynamics between the variables, including the possibility of feedback between them in several instances.

Introduction

Economic theory and empirical evidence have confirmed for over a century that technological development and investment can foster the economic growth. (A pertinent recent survey of such studies is found in Horng et al., 2012.) The more contemporary studies of this vital subject indicate that it is financial development3 specifically that has the considerable potential for disseminating positive externalities throughout the economies that experience it, fostering even greater economic growth (see, for instance, Andersson et al., 2010, Levine, 1999, Levine, 2005, Beck and Levine, 2004, Ward and Zurbruegg, 2002, Beck et al., 2000, Levine et al., 2000, Rousseau and Wachtel, 2000, Levine and Zervos, 1998, Barro and Sala-i-Martin, 1995). Accordingly, the nexus between financial development4 and economic growth is one of the most vibrant research works in development economics, particularly since seminar works of Schumpeter (1911). The finance-growth relationship then becomes important for two specific reasons. First, governments can properly formulate growth-enhancing financial policy. If we can affirm and quantify any causality between financial development and economic growth, then any policies designed to increase/decrease financial flows within an economy would impact on economic growth. Second, these findings can enhance debates on any causal nexus between financial development and economic growth themselves.

Recent5 theoretical and empirical approaches, as articulated by Horng et al. (2012), Levine (2005), Beck et al. (2000), King and Levine (1993a), Robinson (1952), and others, have examined causal relationships between financial development and economic growth. They maintain that financial development is central to fostering long-run economic growth as it facilitates the efficient inter-temporal allocation of resources, capital accumulation, and technological diffusion. This notion supports a “supply-leading hypothesis.” The rival “demand-following hypothesis” states that it is the economic growth that determines financial development. In reality, while financial development may lead to economic growth, the latter may itself lead to further financial development.6

Financial development, which encompasses both banking-sector and stock market developments, can also be linked to insurance-market development (see, for instance, Horng et al., 2012, Ching et al., 2010, Outreville, 1990). Like banks and stock markets development, insurance market development also plays a vital role in generating economic growth (Cristea et al., 2014, Liu and Lee, 2014, Lee et al., 2013a, Lee et al., 2013b, Chang et al., 2013a, Han et al., 2010, Lee et al., 2012, Pan et al., 2012, Hou et al., 2012, Lee, 2011, Lee et al., 2010, Jawadi et al., 2009, Brainard, 2008, Webb et al., 2005, D’Arcy and Gorvett, 2004, Park et al., 2002, Ward and Zurbruegg, 2000, Holsboer, 1999). The importance of the insurance-growth relationship has risen in recent decades because of the greater prominence of insurance within the financial sector (Lee et al., 2013a, Lee et al., 2013b, Outreville, 1991).

Linkages formed in theory between insurance market development and both financial development and economic growth are well-summarized in a number of studies (see, for instance, Cristea et al., 2014, Lee et al., 2013a, Lee et al., 2013b, Horng et al., 2012, Chen et al., 2012, Chang and Lee, 2012, Ward and Zurbruegg, 2000, Brainard, 2008, Outreville, 1996). Some such studies have documented the specific contributions of insurance-market development to the economic growth7 process as well as to the well-being of the poor (see, for example, Lee, 2013, Lee and Chiu, 2012, Erik et al., 2011, Arena, 2008, Vadlamannati, 2008, Skipper, 2001).

Although several papers have considered the causal nexus between different measures of financial development8 and economic growth, or between different measures of insurance-market development and economic growth,9 we bring together these two empirical strands of literature by considering the causal link between all three variables.10 Accordingly, the causal link between any of these two variables is considered in the presence of the third variable in our study. During the course of our empirical investigation we also examine and reveal the nature of possible causal linkages between insurance sector development and financial development.11 In contrast to earlier research in this area, we utilize six12 different measures of insurance market development individually as well as a composite index13 of financial development. Finally, and contrary to all previous work in this area, our paper focuses on the links between the variables identified by using panel cointegration and causality tests applied to a sample of OECD14 countries over the period 1988–2012. Our novel panel-data estimation method allows for more robust estimates by utilizing variations between countries as well as variations over time.

The remainder of this paper is organized as follows. Section 2 provides an overview of three strands of literature, one which examines the relationship between financial development and economic growth, one that focuses on the relationship between insurance market development and economic growth, and the last which scrutinizes the relationship between insurance market development and financial development. Section 3 explains the model and data. Section 4 presents our estimation strategy and this is followed by a section describing the results. The final section contains a summary and the policy implications of our results.

Section snippets

Overview of the literature

The proposition that financial development15 is a vital determinant of economic growth is explored in Pradhan et al. (2014a), Beck and Levine (2004), Calderon and Liu (2003), Graff (2003), and Levine (1997). This body of the literature focuses on a possible link between insurance market development and economic growth (see, for instance, Cristea et al., 2014, Ward

Data, variables, and model

Annual data for the 34 OECD countries spanning over 1988–2012 were obtained from the World Development Indicators published by the World Bank and Sigma Economic Research & Consulting, Switzerland.16

Estimation strategy and empirical results

We test the following three general hypotheses:

  • FID Granger-causes economic growth and vice versa.

  • IMD Granger-causes economic growth and vice versa.

  • FID Granger-causes IMD and vice versa.

More specifically, we test the followings sub-hypotheses:

  • H1A,B: Life insurance density Granger-causes economic growth and vice versa.

  • H2A,B: Life insurance density Granger-causes financial development and vice versa.

  • H3A,B: Non- life insurance density Granger-causes economic growth and vice versa.

  • H4A,B: Non- life

Conclusion and policy implications

This paper investigated causal relationships between insurance market development, financial development, and economic growth for an important spectrum of the world economy. Using panel data relating to selected major OECD countries from 1988 to 2012, we found that insurance market development, financial development, and economic growth are cointegrated. Panel Granger causality tests further confirmed that insurance market development specifically and financial market development overall seem

Acknowledgment

We thank the Editor and an anonymous referee for their comments and suggestions.

References (156)

  • S.S. Chen et al.

    The relationship between globalization and insurance activities: a panel data analysis

    Jpn. World Econ.

    (2013)
  • S. Cheng

    Substitution or complementary effects between banking and stock markets: Evidence from financial openness in Taiwan

    J. Int. Financ. Mark. Inst. Money

    (2012)
  • S. Cheng

    Substitution or complementary effects between banking and stock markets: evidence from financial openness in Taiwan

    J. Int. Financ. Mark. Inst. Money

    (2012)
  • I. Choi

    Unit root tests for panel data

    J. Int. Money Finance

    (2001)
  • D.K. Christopoulos et al.

    Financial development and economic growth: evidence from panel unit root and cointegration tests

    J. Dev. Econ.

    (2004)
  • S.R.N. Colombage

    Financial markets and economic performances: empirical evidence from five industrialized countries

    Res. Int. Bus. Finance

    (2009)
  • M. Cristea et al.

    The relationship between insurance and economic growth in Romania compared to the main results in Europe – a theoretical and empirical analysis

    Procedia Econ. Finance

    (2014)
  • P. Demetriades et al.

    Financial development and economic growth: cointegration and causality tests for 16 countries

    J. Dev. Econ.

    (1996)
  • A.A. Enisan et al.

    Stock market development and economic growth: evidence from seven sub-Saharan African countries

    J. Econ. Bus.

    (2009)
  • M.M.G. Fase et al.

    Financial environment and economic growth in selected Asian countries

    J. Asian Econ.

    (2003)
  • C.W.J. Granger

    Some recent developments in a concept of causality

    J. Econometrics

    (1988)
  • J. Greenwood et al.

    Financial markets in development, and the development of financial markets

    J. Econ. Dyn. Control

    (1997)
  • C. Hassapis et al.

    Investigating the links between growth and stock price changes with empirical evidence from the G7 economies

    Q. Rev. Econ. Finance

    (2002)
  • H. Hou et al.

    Life insurance and Euro zone's economic growth

    Procedia Soc. Behav. Sci.

    (2012)
  • S. Hsueh et al.

    Economic growth and financial development in Asian countries: a bootstrap panel granger causality analysis

    Econ. Model.

    (2013)
  • K.S. Im et al.

    Testing for unit roots in heterogeneous panels

    J. Econometrics

    (2003)
  • A. Jalil et al.

    Finance-growth nexus in china revisited: new evidence from principal components and ARDL bounds tests

    Int. Rev. Econ. Finance

    (2010)
  • M. Kar et al.

    Financial development and economic growth nexus in the MENA countries: bootstrap panel granger causality analysis

    Econ. Model.

    (2011)
  • R. King et al.

    Finance, entrepreneurship and economic growth: theory and evidence

    J. Monet. Econ.

    (1993)
  • C. Lee et al.

    FDI, financial development and economic growth: international evidence

    J. Appl. Econ.

    (2009)
  • C.C. Lee et al.

    The link between life insurance activities and economic growth: some new evidence

    J. Int. Money Finance

    (2013)
  • C.C. Lee et al.

    The impact of real income on insurance penetration: evidence from panel data

    Int. Rev. Econ. Finance

    (2012)
  • C.C. Lee et al.

    Further evidence on property-casualty insurance premiums: do multiple breaks and country characteristics matter?

    Jpn. World Econ.

    (2012)
  • R. Levine

    Law, finance and economic growth

    J. Financ. Intermed.

    (1999)
  • R. Levine

    Finance and growth: theory and evidence

  • S. Abu-Bader et al.

    Financial development and economic growth: empirical evidence from six MENA countries

    Rev. Dev. Econ.

    (2008)
  • M. Adams et al.

    Commercial banking, insurance and economic growth in Sweden between 1830 and 1938

    Account. Bus. Financ. Hist.

    (2009)
  • Y.K. Al-Yousif

    Financial development and economic growth: another look at the evidence from developing countries

    Rev. Financ. Econ.

    (2002)
  • L.A. Andersson et al.

    Life insurance and income growth: the case of Sweden 1830–1950

    Scand. Econ. Hist. Rev.

    (2010)
  • M. Arena

    Does Insurance Market Activities Promote Economic Growth? A Cross-Country Study of Industrialized and Developing Countries. World Bank Policy Research Paper, No. 4098

    (2006)
  • M. Arena

    Does insurance market activity promote economic growth? A cross country study for industrialized and developing countries

    J. Risk Insur.

    (2008)
  • P. Arestis et al.

    Financial development and economic growth: the role of stock markets

    J. Money Credit Bank.

    (2001)
  • K. Avram et al.

    Insurance and economic growth: a cross country examination

  • R.J. Barro et al.

    Economic Growth

    (1995)
  • T. Beck et al.

    Economic, demographic, and institutional determinants of life insurance consumption across countries

    World Bank Econ. Rev.

    (2003)
  • M. Beenstock et al.

    The determination of life premiums: an international cross-section analysis 1970–1981

    Insur. Math. Econ.

    (1986)
  • M. Beenstock et al.

    The relationship between property-liability insurance premiums and income: an international analysis

    J. Risk Insur.

    (1988)
  • V.R. Bencivenga et al.

    Financial intermediation and endogenous growth

    Rev. Econ. Stud.

    (1991)
  • T.K. Boon

    Do Commercial Banks, Stock Markets and Insurance Market Promote Economic Growth? An Analysis of the Singapore Economy. Working Paper

    (2005)
  • G. Boulila et al.

    Financial development and long run growth: evidence from Tunisia: 1962–1997

    Sav. Dev.

    (2004)
  • Cited by (44)

    • Do Muslim economies need insurance to grow? Answer from rigorous empirical evidence

      2023, Quarterly Review of Economics and Finance
      Citation Excerpt :

      Zouhaier (2014) examined the relationship between insurance and economic growth of 23 OECD and found the positive impact of non-life insurance on economic growth. Pradhan, Arvin, and Norman (2015) examined causal relationship between insurance market development, financial development, and economic growth in 34 OECD countries for the period of 1988−2012. Using panel Granger causality, they found insurance market development, in addition to financial market development contributes to economic growth in the long run whereas, short run is characterized by feedback effect.

    • Re-investigating the insurance-growth nexus using common factors

      2022, Finance Research Letters
      Citation Excerpt :

      Overall, the majority of the most recent empirical literature confirms the existence of a long-term relationship between economic growth and insurance activity. For example, Pradhan et al. (2015) analyze 34 OECD countries from 1988 to 2012 to test for long-term Granger causality. Moreover, Liu et al. (2016) apply rolling vector autoregressions to examine G7 countries for the period of 1980–2011 and, thus, address the problem of structural breaks in the data.

    • Impact of interest rates on the life insurance market development: Cross-country evidence

      2021, Research in International Business and Finance
      Citation Excerpt :

      However, the insurance industry has idiosyncratic features that are not clearly explored. Our study contributes to understanding the extent to which the insurance market could impact and be impacted by financial and economic conditions (Azman-Saini and Smith, 2011; Pradhan et al., 2015, 2016). This work does not aim to explain the relationship between supply and demand for insurance, although several authors highlight that the macroeconomic, demographic, social, and institutional aspects can influence consumers’ behavior and also firms’ willingness to operate in certain segments (Beenstock et al., 1986; Beck and Webb, 2003; Li et al., 2007; Dragos, 2014).

    View all citing articles on Scopus
    1

    Tel.: +1 705 748 1011x7299; fax: +1 705 748 1567.

    2

    Tel.: +61 95926120; mobile: +61 8344 5327/0414 653 770.

    View full text