An Empirical Analysis between Financial Development, Economic Freedom, and Economic Growth

This study examines the effects of financial development and economic freedom on production by adopting a combination of the new index of financial development and economic freedom. The augmented Cobb-Douglas production function is developed to estimate the relationship between financial sector development, economic freedom and total output. In order to investigate the relationship between these variables, a panel analysis is used for 107 countries from 1996 to 2016. We show that there is a positive correlation between financial development and the output variable. Also, the coefficient of the quadratic term of financial development is negative, thus supporting the over-financialization hypothesis. Moreover, the positive correlation between economic freedom and total output is confirmed. Of particular interest is the finding of a negative and significant coefficient of the interaction term of financial development and economic freedom. It suggests that the marginal returns to economic growth from financial development declines more for countries with higher level of economic freedom.