Impact of ICT diffusion and financial development on economic growth in developing countries.
| Autor | Verma, Anushka |
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Introduction
Financial development, one of the most significant economic growth determinants, has been thoroughly explored in existing literature (Pradhan et al., 2018; Samargandi et al., 2019; Sehrawat and Giri, 2016; Verma and Giri, 2020). Financial services reduce transactional costs and enhance resource allocation, leading to economic growth through information accumulation, monitoring investments, risk allocation and savings, and enabling a smooth flow of goods and services (Demirguc-Kunt and Levine, 1996). Recently, there have been tremendous revolutions in the financial and banking sectors under the accelerated advancement of information and communication technologies (ICT). The worldwide financial industry spent more than $197bn on ICT products and services in 2014 and has been the single largest purchaser of ICT products and services since the mid-1990s (Cheng et al, 2021). Since the 1980s, the transmission and operation of digital information have been at the core of the financial sector's evolution.
Consequently, the interdependence between technology and finance impacts the relationship between financial development and economic growth. The significance and relevance of ICTs are such that, in the contemporary world, the comparative advantage of a developing economy in national resources and reserve has diminished compared to the competitive edge generated by technology (Kpodar and Andrianaivo, 2011). Thus, investing in the ICT industry results in enhanced value addition and increases efficiency (Pohjola, 2001). The World Bank (2020) has also collaborated with clients and significantly supported reforms in the ICT industry through technical support and lending activities in recent years. To keep up with this trend, several financial institutions combine ICT with internal operational modernization and provide new services, such as payment processing, remittance and money transfers via smartphones. The impact of ICT dissemination on financial evolution may have various implications on economic activity, depending on the factors above.
The economic theory of Cobb and Douglas (1928) states that the production function consists of three production components: labour, capital and technology, and that shifts in any of these three factors affect economic growth. Financial development is commonly used to represent a capital improvement in the context of production elements, whereas the expansion of ICT represents technological innovation. Additionally, the financial sector can accumulate savings, allocate resources to the most lucrative ventures, minimize information and transaction costs, and enable inter-industry commerce. The consequence is a more efficient use of resources and rapid progress in human capital technology (Greenwood and Smith, 1997; Levine, 1997). However, as the global banking crisis of 2008 showed, weak banking institutions can lead to resource misallocation, waste, reduced savings, increased speculation, fewer investments and fewer returns on those investments. Research on the relationship between finance and economic growth has yielded positive and negative outcomes. Some causes include an increase in the frequency of financial crises or a dearth of publicly traded corporations to spur expansion and non-linear relationships (Samargandi et al., 2019).
Although ICT is one of the fundamental causes for faster economic progress, its impact on economic growth has been the subject of substantial scholarly attention in recent years. Through electronic encoding and virtual mobility, ICT facilitates the dissemination of information, which affects the development and technology of many businesses and modifies economic activity. However, empirical research has produced conflicting findings, despite widespread assumptions in the theoretical literature that more widespread use of ICTs will boost economic growth. While some studies have found favourable impacts (Cheng et al, 2021; Hwang and Shin, 2017; Verma and Giri, 2020), others showed insignificant, ambiguous or negative relationships (Veeramacheneni et al, 2007).
Furthermore, many modern theories of economic growth recognized the significance of ICT. These include Neo-Schumpeterian models predicated on Kondratiev's concept of cyclical growth consisting of economic boom and bust in the long term and Schumpeter's ideas, which emphasize the role of inventors and enterprises in capitalizing on market inefficiencies to lay the basis for future economic expansion (Pyka and Andersen, 2012; Schumpeter and Backhaus, 2003). These ideas typically coincide with technological and economic breakthroughs. To be truly "pervasive", ICT applications must significantly impact virtually every sector of the economy (Avgerou, 1998).
The existing studies focus solely on the relationship between ICT diffusion and economic growth without looking into the causal relationships. Thus, one primary purpose of this study is to examine the causal dynamics of ICT infrastructure in greater detail than in the past literature. Using a panel data approach and considering the influence of financial sector development, this study investigates the short-term and long-term link between ICT diffusion and economic growth in developing nations. For this purpose, the study examines the possible causation amongst ICT diffusion, financial sector development and economic growth in 88 developing countries between 2005 and 2019. The methodological framework combines ICT diffusion with the pre-existing finance-growth nexus. It analyses the dynamics of ICT diffusion, financial sector development and economic growth by employing panel vector autoregressive (VAR) models with exogenous variables and the Granger causality approach.
The present study is segregated in this manner: Section 2 covers the literature review; Section 3 presents the data and methodology employed; Section4covers the empirical results; Section 5 offers the discussion and section 6 concludes with policy implications.
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Literature review
2.1 ICT diffusion and economic growth
The first body of research investigates the connection between ICT diffusion and economic growth. Theoretically, ICT diffusion and economic growth appear to be a significant link. ICT is an external and uncontrollable force that develops from government action or corporate initiatives and reveals itself through productivity gains in real economic activity. Economic growth is a widely discussed and ever-evolving subject for economists. In his ground breaking theory of economic development, Smith (1776) recognized that rising labour productivity is a direct result of technological progress in the economy. While the classical theory (Smith, 1776) emphasized specialization to increase productivity, the neo-classical theories (Solow, 1956) posited growth via increased workforce and productivity through technological progress. Thus, focussing on human capital formation and investments in health and education programs increases productivity. Romer (1986), in contrast to the then-prevailing neo-classical growth theories, put out the AK model of growth, which integrated technological knowledge as an endogenous factor.
Four hypotheses describe the causal relationship between economic growth and ICT diffusion. First, the ICT diffusion-driven economic growth theory, often known as a supply-leading hypothesis, proposes that ICT diffusion causes economic growth in a unidirectional manner (Alimi and Adediran, 2020; Pradhan et al., 2018, 2021; Sawng et al., 2021). This argument is based on the premise that increased investment in ICT infrastructure and consequent increased use of ICT boosts employment possibilities and the productivity of firms, which positively contributes to economic growth. Growing ICT infrastructure creates more jobs and new digital enterprises, which benefits economic expansion. The second school of thought, the demand-following hypothesis, asserts that economic development granger-causes ICT diffusion. This theory assumes that as a country develops economically, it can invest more in ICT infrastructure, allowing it to serve a broader range of individuals and businesses. According to the data, advanced economies rely increasingly on the digital economy to maintain their global market edge. As a result, they have expedited the development of more advanced ICT infrastructure. Studies exploring these associations include those by Beil et al. (2005), Lee (2011) and Salahuddin and Gow (2016). Additionally, Chakraborty and Nandi (2011), Ramlan and Ahmed (2009) and Shiu and Lam (2008) support the feedback hypothesis by demonstrating the presence of a bidirectional causal relationship among the variables. Finally, some studies indicate that the variables have no causal association (Dutta, 2001; Shiu and Lam, 2008; Veeramacheneni et al., 2007).
2.2 Financial development and economic growth
The second strand examines the possible association between financial sector development and economic growth, the theoretical foundation of which lines back to Gurley and Shaw (1955), Schumpeter and Backhaus (2003) and Thornton and Poudyal (1990). They suggested that creating financial institutions such as banks can optimize resource distribution and accelerate technological advancement in production, thereby boosting economic growth. Further, financial development helps minimize transaction costs, decrease monitoring costs, reduce information symmetry and increase financial inclusion (King and Levine, 1993). The initial endogenous theories focused on allocative efficiency and the role of the financial sector in financial inclusion (Goldsmith, 1969). However, King and Levine (1993) and Saint-Paul (1992) endorsed financial development since it creates diversified portfolios, reduces risks, increases liquidity and boosts economic growth by increasing demand.
The link between economic growth and financial development is the subject of competing hypotheses...
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