An examination of the impact of financial deepening on long-run economic growth: An application of a VECM structure to a middle-income country context

This paper examines the impact of financial deepening on long run economic growth in South Africa over the period 1954-92. Two models are developed using the Johansen VECM structure. The first model investigates whether the financial system has a direct or indirect effect on per capital output via the investment rate. The second model attempts to investigate the possibility of feedback effects between the financial and real sectors. We find that both dimensions of the financial system – financial intermediation and securities – affect economic growth in both models. Furthermore, both models reveal that the financial system has an indirect effect on GDP via the investment rate.
Feedback effects are also found to exist between the real and financial sectors. One interpretation of the evidence is that credit rationing is prevalent in South Africa with firms extensively relying on internal finance to meet their financing requirements.