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Growth Effects of Financial Globalization ∗

Abstract We investigate the growth effects of financial globalization, giving particular consideration to potential conditionality of these growth effects on the level of a country’s institutional and financial market development. To capture such conditionality, we extend recently developed heterogeneous dynamic panel data models to account for bivariate long-run conditional parameter homogeneity. This framework appears to have great appeal relative to the typical model specification in the existing empirical literature, inter alia allowing for rich, country-specific growth dynamics as well as a continuous range of thresholds. To estimate our model, we construct novel indices of institutional and financial market development for a panel involving 60 industrial, emerging market and developing countries over the time period 1970 to 2006. Our estimation results indicate critical dependence of the output level and growth effects of financial globalization on the level of a country’s institutional and financial market development. This dependence involves sizeable variation of the output growth effects of financial globalization across the complete range of stages of institutional and financial market development observed in our panel, and thus would not be well characterized by a typical threshold model. For some countries almost exclusively OECD member countries we find rather sizeable positive long-run effects of financial globalization on the growth rate and level of output per capita. In contrast, for numerous of the developing and emerging market countries we find that the long-run effects of financial globalization on the growth rate and level of output per capita are strongly negative.