Does Growth Cause Financial Deregulation in China? An Instrumental Variables Approach

Following Miguel et al. (2004), we use temperature and hours of sunshine variations as instrumental variables for economic growth in 27 Chinese provinces during 1981--98. Our 2SLS (Two-stage least squares) regression finds that growth has no significant effect on financial deregulation after controlling for predetermined home-bias political variable, population size, and time and province effects. Moreover, the home-bias political variable has a significant effect on financial deregulation, which shows that political and cultural factors are important driving forces in determining the path and logic of Chinese financial deregulation. The results hold up when we use GMM (Generalized method of moments) to deal with heteroskedasticity. The results are also robust in LIML (Limited information maximum likelihood) estimation that deals with weak instruments.