The financial sector and poverty in the MENA countries

The link between financial development and economic growth has been one of the long-debated theoretical issues - whether the financial sector actually contributes to the real sector in the process of economic development. The empirical works reveal that there is no universal consensus on the causal relationship between financial development and economic growth. In fact, the empirical evidence suggests that the relationship between financial development and economic growth is sensitive to choice of the proxy used for the measurement of financial development in most cases. Despite several previous studies on the MENA region having provided similar conflicting results on the causality issue, the causal relationship between financial development and poverty reduction has been neglected. Previous studies on this subject concerning the MENA countries largely utilize a bivariate causality analysis and may, therefore, suffer from the omission of variable bias. Recently it has been argued that financial development might directly cause poverty alleviation emanating from the availability of accessible financial instruments, services and institutions for poor households. Therefore, the introduction of a third variable affecting both financial and economic growth in the bivariate framework may alter not only the direction of causality between the two variables, but also the magnitude of the estimate. To our best of knowledge, there is not any study which has gone the full distance to empirically examine the impact of financial development and economic growth on the ultimate policy goal, i.e. poverty reduction for the MENA countries. This study tries to contribute to the literature by examining the causal relationship among financial development, economic growth and poverty reduction in the MENA region. In this regard, this chapter attempts to answer two critical questions: (1) Does financial development (economic growth), which results from economic growth (financial development), lead to poverty reduction in the MENA region? (2) Which sector leads in the process of poverty reduction in the MENA - the financial sector or the real sector? In order empirically to investigate the interactions among these variables, this chapter employs a trivariate modelling framework by employing the recent developments in the panel data analysis for the period 1980-2007.