Investigating the Role of Financial Development on the Effects of Natural Resource Rents on other Kinds of Capital in Iran

IntroductionFinancial system is fundamental for economic growth in most of countries. Based on vast studies done on the determinants of economic growth, financial development leads to economic growth in many countries in long time (Rousseau & Wachtel, 2002). It is worth noting that the importance of financial system in economic growth has been notified for many years (e.g., Bagehot, 1873; Hicks, 1969; McKinnon & Shaw, 1973; King & Levin, 1993; Levin, 1997, 2002; Beck, Demirguc-Kunt & Levine 2000; Aizenman, 2015).
Although there is a vast literature about the importance of financial development, most of them have investigated the direct impact of financial development on economic growth. In this case it is important to know that there are four main channels that contribute to the relationship between financial development and overall economic output that are foreign capital, physical capital, human capital, and social capital. Based on World Bank’s analysis (2012), these five kinds of capital form national wealth in all economies. Meanwhile natural capital has the main role in resource-rich countries.
There is an expanding literature that shows the effects on natural resource rents on economic growth in resource-rich countries. Gylfason (2001) introduced four main channels that consist of four kinds of capital mentioned above to show how resource rents affect economic growth.
One of the important issues that have been neglected in this concept is how resource-rich countries can reverse the negative effects or improve the positive effects of resource rents on capital accumulation. There are few studies that argue financial development is an effective solution for that aim.
2) Theoretical Framework
Four kinds of capital that contribute to the relationship between resource rents and economic growth are foreign capital, physical capital, human capital and social capital. In fact natural capital will affect them in all resource-rich countries. Hence, the first step is to investigate the simultaneous effects of natural capital on other kinds of capital.
The conceptual model of this paper is that financial development is an infrastructure that has potential in improving the positive (or reducing negative) impact of natural resources on all kinds of capital accumulation. Therefore, the second step of this study is investigating the role of financial development on the effects of natural resources on accumulation of this kind of capital.
In this paper, we will show that financial development could absorb resource rents in order to allocate resources and invest them in most optimal projects. For more details it would be necessary to say that the debate about the influence of financial development on economic growth has been ongoing for more than a century. Since Schumpeter (1912) believed that financial development affects economic activity and hence economic growth. In fact, financial development has emerged as one of the policy levers central banks and governments use to target economic growth.
In fact, financial development is based on the financial development index which provides a measure for the breadth, depth and efficiency of financial systems. Generally, financial development is the factors, policies and institutions that lead to effective financial intermediation and markets, as well as deep and broad access to capital and financial services. To achieve a coherent view about financial development it would be necessary to know the main financial system functions. These are:Facilitating the trading, hedging, diversifying and pooling of the risks;
Allocating financial resources;
Monitoring managers and exerting corporate control;
Mobilizing savings;
Facilitating the exchange of goods and services (Levine, 1997).
Governments in developing resource-rich countries in order to achieve the optimal use of resource rents could stimulate financial development through some macroeconomic policies (Huang, 2010). One of the probable results of financial development is to smooth consumption of below-ground wealth across generations. Other consequence of financial development will be seen in isolating government budgets from volatile resource prices, allowing the budgetary process to be conducted with more certainty.
MethodologyThis paper provides a model for investigating the simultaneous effects of natural resource rents on four kinds of capital accumulation using SUR model. In second step, for investigating the role of financial development index on the effects of natural resource rents on all kinds of capital, we have utilized Rolling Regression technique. This method is suitable for testing the effects of one variable on two other variables in a model. Also, it is worth noting that the multi-dimension financial development index that consists of 8 main financial indices in banking sector is made by PCA method.
Results and DiscussionBased on the results of SUR estimator, resource rent has positive effect on foreign and social capital but it has negative effect on physical capital. There are various effects from resource rents on human capital accumulation; sometimes, it has positive and sometimes it has negative effect. It shows that natural resource rents have different effect on each kinds of capital accumulation in Iran during 15 rolling regression (fixed) windows that have 30 observations for each variable in one window. As is evident in this paper, the total natural resource rents itself is not a curse for the economy, but it could be a blessing. One of the important reasons for the negative effect of resources on physical capital is more governmental investments in this sector and there are some rent-seeking activities that prevent resources from mobilizing to productive projects.
The results of rolling regression show that the development of financial banking system can improve the effects of resource rents on physical and social capital in Iran. But we do not get the same results for foreign capital and human capital. In foreign capital sector, ignoring the development of external dimension of financial banking system that may be seen as financial liberalization is one of the main reasons for this event.
The reason for undesirable effect of financial development in human capital sector relates to low level of financial innovation in banking sector and high level of risks that banks are faced with. Consequently, many innovative projects from people who have high level of human capital accumulation will not be considered in Iran.
Conclusion and SuggestionsNatural resource management is one of the important issues in resource-rich countries. Based on the results, financial development can mitigate the negative effect or improve the positive effects of these rents on capital accumulation. The results show that financial development would be beneficial for this aim in physical and social capital sector in Iran. But it cannot improve the effects of resource rents on foreign and human capital accumulation.
Based on the results, we could suggest that considering development of financial system is a necessity in resource-rich countries such as Iran. Meanwhile the important issue is focusing on all financial development channels that lead to balanced development in financial system. Also, it is worth noting that policy makers should avoid financial repression because this would prevent it from imposing positive effects on the economy. At the end, we could say that paying attention to all kinds of capital would lead to sustainable economic growth when it is accompanied by stable financial development.