Financial-System Reform and Economic Growth in a Transition Economy: The Case of China, 1978-2004

The relationship between financial-system reform and growth is of continuing interest and the subject of ongoing research; yet many aspects of it remain unclear. This paper contributes to the literature by an analysis of this relationship using Chinese time-series data. China is a particularly interesting subject for such a study since it has undergone rapid and wide-ranging financial liberalisation since economic reforms began in 1978 thus providing a rich source of data. We construct an index of financial liberalisation by combining the ‘Delphi method’ and principal components analysis to combine eight aspects of the reform process for 1978 to 2004. We tackle the question of the finance-growth nexus by estimating and simulating a VAR model of growth, saving and liberalisation. We find robust evidence of significant positive effects of liberalisation on growth in the short run and on accumulated growth in the long run but weak and predominantly negative effects of liberalisation on saving. Tests of short-run Granger causality show that liberalisation significantly causes both growth and saving but that there are no significant feedbacks to liberalisation.