Do Both Demand-Following and Supply-Leading Theories Hold True in Developing Countries?

41 Pages Posted: 2 Jul 2018

See all articles by Sheung-Chi Chow

Sheung-Chi Chow

The Hang Seng University of Hong Kong; Hong Kong Baptist University (HKBU)

João Paulo Vieito

Scholl of Business Studies - Polytechnic Instituto of Viana do Castelo

Wing-Keung Wong

Asia University, Department of Finance

Date Written: June 18, 2018

Abstract

To overcome the limitations of the traditional approach which uses linear causality to examine whether the supply-leading and demand-following theories hold. As certain countries will be found not to follow the theory by using the traditional approach, this paper first suggests using all the proxies of financial development and economic growth as well as both multivariate and bivariate linear and nonlinear causality tests to analyze the relationship between financial development and economic growth. The multivariate nonlinear test not only takes into consideration both dependent and joint effects among variables, but is also able to detect a multivariate nonlinear deterministic process that cannot be detected by using any linear causality test. We find five more countries in which the supply-leading hypothesis and/or demand-following hypothesis hold true than with the traditional approach. However, there is still one country, Pakistan, for which no linear or nonlinear causality is found between its financial development and economic growth.

To overcome this limitation, this paper suggests including cointegration in the analysis. This leads us to conclude that either supply-leading or demand-following hypotheses or both hold for all countries without any exception. There will be some types of relationships between economic growth and financial development in any country such that either they move together or economic growth causes financial development or financial development causes economic growth without any exception. The finding in our paper is may be useful for governments, politicians, and other international institutions in their decision making process for the development of the countries and reducing poverty.

Keywords: financial development, economic growth, cointegration, linear causality, nonlinear causality, developing countries, supply-leading hypothesis, demand-following theory

JEL Classification: G20, O40, C12

Suggested Citation

Chow, Sheung-Chi and Vieito, João Paulo and Wong, Wing-Keung, Do Both Demand-Following and Supply-Leading Theories Hold True in Developing Countries? (June 18, 2018). Available at SSRN: https://ssrn.com/abstract=3198005 or http://dx.doi.org/10.2139/ssrn.3198005

Sheung-Chi Chow

The Hang Seng University of Hong Kong ( email )

Hang Shin Link
Siu Lek Yuen
Shatin, Hong Kong
China

Hong Kong Baptist University (HKBU) ( email )

Department of Economics
Kowloon, Hong Kong
Hong Kong

João Paulo Vieito

Scholl of Business Studies - Polytechnic Instituto of Viana do Castelo ( email )

Avenida Miguel Dantas
Valença, 4930
Portugal

Wing-Keung Wong (Contact Author)

Asia University, Department of Finance ( email )

Taiwan
Taiwan

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