Introduction

The exhaustion of the Substitutive Industrialization Model (MIS) gave rise to intense debates on pursuing new economic objectives. Along this path, during the second half of the 1980s and early 1990s, many semi-industrialized countries, particularly Latin America, began transitioning to an open economy model (OEM) rooted in trade liberalization and financial deregulation. The guiding principle of this metamorphosis would be to correct the profound macroeconomic imbalances accumulated during the operation of the MIS, such as the substantial deficit in public finances, the size and cost of the debt, exchange rate volatility, price instability, and loss of economic competitiveness. Certainly, several structural reforms would be implemented to ensure optimal integration into world markets and achieve sustained long-term economic growth rates, anchored to the expansion of the export manufacturing sector.

Nevertheless, the macroeconomic results of the last four decades are contradictory; while some economies, such as those in Asia, have achieved a strong expansion of economic activity, other countries, such as those in Latin America, show mixed and less robust patterns. An example of this dichotomy is South Korea and Mexico. While the former has managed to move from a context of underdevelopment to the world technological frontier, a process based on the consolidation of savings and investment, the latter has followed a pattern of industrialization based on the intermediate stages of global value chains, with clear restrictions on credit and financial capitalization.

At a theoretical level, endogenous growth models position the financial system as an essential source of output expansion since its consolidation has a significant impact on the capacity of agents (countries or industries) to accumulate factors that generate externalities (human capital and R&D spending) and, thus, on the rate of innovation, to the extent that this process reduces the costs associated with the allocation and management of resources and risk management (^{Aghion & Howitt, 2009}). At the empirical level, the results are mixed and inconclusive regarding this link, due to persistent conceptual and methodological difficulties, especially in the robustness of the indicators used to characterize the structure of the financial system and the level of disaggregation of the analysis (^{Liu & Zhang 2020}; ^{Botev et al., 2019}; ^{Asteriou & Spanos, 2019}; ^{Pan & Mishra, 2018}; ^{Durusu-Ciftci et al., 2017}; ^{Murari, 2017}; ^{Levine, 2005}).

Accordingly, this study seeks to answer what impact the expansion of the capital market and the banking system have on a product's performance in Argentina, Brazil, Chile, Colombia, and Mexico. This research aims to obtain consistent evidence that makes it possible to trace the dynamic effects of financial development on the economic growth rate and those associated with international trade and domestic technological innovation. Therefore, it is conjectured that those economies with lower financial frictions will be able to achieve higher rates of innovation and competitiveness, a condition that could provide a sustained boost to output growth in the long term.

The contribution of this study is twofold: on the one hand, the simultaneous effect of the consolidation of the structure, activity, and efficiency of the financial system is evaluated, which will permit greater analytical precision in the channels through which effective gains are generated on the dynamics of output, for the case of emerging economies; on the other hand, the hypothesis test is carried out based on an autoregressive model with lags distributed for panel (ARDLP), a methodological resource that produces unbiased estimates of the coefficients, derived from possible endogeneity problems or restrictions in the size of the sample (^{Pesaran et al., 2001}).

The document is organized as follows. The first and second sections present a review of the theoretical and empirical state of the art on the externalities associated with the consolidation of the financial system to learn about the main results and methodologies used for this topic. The third section describes some stylized facts about macroeconomic and financial dynamics in Latin America to outline a preliminary causal relation between financial development, productivity, and economic growth. In the fourth part, the hypothesis testing is performed.

Innovation, growth, and the financial system: Theoretical elements

In the theory of economic growth, two approaches can be identified. The first is the supply-side approach, in which the dynamics of output, in the long run, are determined by technological progress (TP) and therefore by the inherent conditions of the production process. Two distinctive perspectives make up this view: the neoclassical theory, where the rate of innovation is exogenous to the economic system, and the endogenous theory, where technological change is subject to immediate sources (human capital and R&D spending) that generate externalities and fundamental causes (international trade, institutions, or the financial system), whose nature affects the capacity of countries to accumulate factors of production (^{Aghion & Howitt, 2009}; ^{Romer, 1990}; ^{Lucas, 1988}).

On the other hand, the demand approach emphasizes that output variations are constrained by the dynamics of effective demand (domestic and external); the dialectic of this construct originates from investment-led growth models, going from those explained by income distribution to those that emphasize the role of the super multiplier and the external constraint (^{Romero & McCombie, 2018}; ^{Dutt & Ros, 2007}; ^{Thirlwall, 2003}; ^{Barbosa-Filho, 2000}).

Naturally, the purpose of this research is not to carry out an exhaustive review and enumeration of the characteristics of the theoretical models but to highlight the mechanisms through which the development of the financial system generates dynamic gains for economic functioning in the context of endogenous growth models (EGM).

Financial development and economic growth: A review of the empirical literature

The results in the empirical literature on the impact of financial development on economic growth are mixed and inconclusive, particularly in the case of emerging economies, a condition inherent to the conceptual and methodological difficulties present in empirical operationalization, either due to the way the causal relation is approached, the robustness of the indicators used to characterize the structure of the financial system, or the level of aggregation of the analysis (^{Liu & Zhang 2020}; ^{Botev et al., 2019}; ^{Asteriou & Spanos, 2019}; ^{Pan & Mishra, 2018}; ^{Durusu-Ciftci et al., 2017}; ^{Murari, 2017}; ^{Levine, 2005}).

In their results, ^{Liu and Zhang (2020)}, in a study of 29 provinces in China from 1996-2013, find that capital market consolidation —stock market capitalization/bank credit— constitutes a driver of GDP per capita. Nevertheless, this effect varies according to the stage of technological development. They also find that the development of financial services negatively impacts GDP performance due to the high concentration of financing in state-owned companies, whose efficiency is relatively low. Their estimates, in turn, show that capital accumulation (physical and human) and trade openness play a cardinal role in this link and provide evidence of conditional convergence among Chinese regions.

In a study of 47 countries over the period 1970-2016, ^{Yan (2019)} finds, using a panel-corrected standard error and vector autoregressive model, that increases in credit, stock market capitalization, and government spending generate a positive impact on GDP per capita growth, total factor productivity, and capital accumulation, with stock market liquidity being the most relevant factor. Moreover, the results suggest a circular motion between credit consolidation and inflation, a condition that imposes restrictions on economic expansion in the case of middle-income economies.

The findings of ^{Botev et al. (2019)}, in a study of 128 countries in the period 1990-2012, suggest (linear estimation) that increasing credit and stock market capitalization generates an increase in GDP per capita, although the financial liberalization index lacked statistical significance. Similarly, the non-linear regressions showed that the expansion of bank and stock market financing is a driver of output. In this regard, they find that greater stock market development reinforces the effect of credit on economic dynamics, although the evidence for the hypothesis of complementarity between the banking system and the stock market is weak.

In a paper on 26 European Union countries during the period 1990-2016, through a panel-corrected standard error model, ^{Asteriou and Spanos (2019)} indicate that bank assets, stock market capitalization, and stock turnover index generate a positive effect on the GDP growth rate, contrary to the liquid liabilities indicator, which lacked statistical significance. They also show that trade openness is a driving factor of economic dynamics, while inflation and FDI had a negative impact. These results confirm the preponderant role of financial development in economic growth and bank capital adequacy in financial stability.

Based on an ARDL model with estimates for the case of China, over the period 2005:07-2015:11, ^{Pan and Mishra (2018)} find a mixed effect of the stock market on the industrial production index, negative with the stock market value of class A shares, listed in Shanghai, and positive with the series B shares, listed in Shenzhen. In addition, they detect that the financial ruptures of 2007-2012 had a meaningful impact on both the goods and services market and the stock market. Additionally, they find unidirectional causality from telecommunications and public services (state monopolies) to output performance and a bidirectional relation of monetary (M1) and fiscal policy with output expansion and the financial system.

Using a dynamic panel, in a paper for 116 countries over the period 1991-2014, ^{Ruíz (2018)} studies the relevance of institutional investors (pension fund, insurance company assets and mutual funds) in the consolidation of the financial system and the effects of the latter on economic performance. His results show that providing credit to the private sector harms the growth rate of GDP per capita if the participation of institutional investors in the financial market is below the average threshold; in contrast, if the size of institutional funds is larger than the average threshold, the impact is positive.

The empirical estimates, based on static and dynamic panel estimators, of ^{Aali-Bujari et al. (2017)}, in a study of Latin America (Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela) during the period 1994-2012, suggest that the consolidation of both stock market capitalization and domestic credit generates a positive impact on the economic growth rate, although this effect is more significant with the increase in stock market liquidity; they also warn that the widening of interest rate spreads causes a contraction of GDP per capita.

^{Durusu-Ciftci et al. (2017)}, in their regressions based on a sample of 40 countries over 1989-2011, find that the development of financial markets is a determinant of GDP per capita dynamics. Nevertheless, at the country level, the evidence is mixed. For Mexico, the results do not show a statistically meaningful impact, in contrast to the evidence for Brazil and Colombia, which suggests a positive effect of both private credit and equity on economic growth.

In a paper on Bhutan, India, Malaysia, Pakistan, and Sri Lanka over the period 1980-2013, ^{Murari (2017)}, using a dynamic panel, finds that an increase in total credit, stock market capitalization, and FDI promotes GDP expansion; nonetheless, the evidence is ambiguous on the effect that credit extended to the private sector exerts on economic activity. Consequently, he concludes, those countries with stronger financial institutions tend to grow faster.

The findings of ^{Prochniak and Wasiak (2017)} in a study of 28 European Union and 34 OECD countries in the period 1993-2013 confirm that changes in credit, stock market capitalization and stock turnover rate generate a positive effect on the dynamics of GDP per capita, while an increase in non-performing loans and bank capital induces a contraction of output per person, which confirms (they claim) the financial system as an essential source of economic growth.

In a paper on Mexico in the period 1990-2013, ^{López and Basilio (2016)} observe a unidirectional causal relation of GDP per capita growth to financial development, which rules out the hypothesis that the development of the financial system promotes economic growth, given the increasing provision of credit to households, and, therefore, the rationing of credit to the production sector. Similarly, ^{Cermeño et al. (2016)} find unidirectional causality from financial development to the GDP growth rate for the United States, while estimates for Mexico show that GDP variations determine the financial system's evolution.

In another study for Mexico in the period 1993-2011, ^{Castillo-Ponce et al. (2015)} found, in general terms, that the GDP growth rate maintains a long-term co-movement with the development of the stock market (stock market price index, the level of stock market operations, and the stock market capitalization value). These results conclude that sound financial markets provide greater capital liquidity and promote economic growth.

Also, using data from Mexico during the period 2000-2010, ^{Zavaleta and Martínez (2015)} show, on the one hand, that an increase in the index of prices and quotations of the Mexican stock market generates a positive impact on the Index of Global Economic Activity (IGAE) and, on the other hand, a unidirectional causal relation from the stock market to the IGAE. In addition, they state that the Mexican stock market constitutes a significant source of financing for the growth and development of production.

In a study of Argentina, Colombia, Mexico, and Peru during the period 1986-2009, ^{Ruíz and Rosales (2014)} find, using a dynamic panel, that the evolution of the financial system (activity, size, and efficiency) directly impacts economic activity. Nevertheless, the effect of bank consolidation⁴ on the expansion of output lacked statistical significance; in contrast, their results show that the increase in bank profitability and performance constitutes a driver of financial development, indirectly boosting GDP per capita.

The results of ^{Bittencourt (2012)}, in a paper on Latin America (Argentina, Bolivia, Brazil, and Peru) during the period 1980-2007, confirm the speculation that the development of the financial system (stock market capital, size, and banking activity), as well as the increase in the investment rate, promote the growth of GDP per capita, while an increase in government spending contracts output. According to this paper, good macroeconomic and institutional performance (e.g., central bank autonomy and sound public accounts) are necessary for strengthening this link.

Similarly, ^{Terceño and Guercio (2011)}, in another study on Latin America (Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela) between 1990-2007, find a positive effect of the financial system on production -with bank assets as the most significant channel-, although the importance of capital markets in Argentina, Chile, Peru, and Mexico has increased significantly. With these data, the authors conclude that the banking sector represents a central element in the financing of economic activity in Latin America.

In their regressions for Mexico during 1995-2010, ^{Cruz and Alcántara (2011)} find -at the aggregate level- a positive effect of total (and consumer) credit on the Index of Overall Economic Activity (IGAE), while at the sectoral level, the association is significant only between the IGAE of the tertiary sector and the financing granted to it. At the same time, they find unidirectional causality from private credit provided to the service sector to economic performance and bidirectional causality between consumer credit and the IGAE. Despite these results, they point out that the orientation of the banking system toward household consumption constitutes a restrictive condition for the development of innovation and industrial competitiveness.

To summarize, many empirical studies partially examine the different channels through which financial development impacts the evolution of output. This condition could subject the results to over/underestimation biases, as well as the omission of relevant variables (e.g., institutional quality, international trade, or FDI), and thus skew the proper interpretation of the empirical evidence; consequently, the empirical analysis should focus on the simultaneous analysis of the consolidation of the stock market as well as the banking system.

Latin America: Macroeconomic and financial trends

The persistent macroeconomic imbalances⁵ accumulated during the operation of the MIS in Latin America provoked (throughout the 1980s and early 1990s) an intense debate on the efficiency and continuity of this critical strategy, despite the remarkable expansion of GDP and per capita output that the region experienced in those years (their average annual expansion rate during 1960-1980 was 5.8% and 3.1%, respectively). This debate led to the establishment of a new development strategy based on trade and financial openness, aimed at reducing the volatility of relative prices, reducing economic and financial vulnerability to external shocks, and increasing technology transfer, developing the financial system with the orientation of increasing financial instruments, strengthening financial and monetary cooperation, expanding the savings rate, credit, and capital flow, stabilizing the interest rate and regulating organizational and corporate functioning; promoting productive reconversion (based on increasing competitiveness and sectoral productivity), and ensuring a sustained increase in added value (^{Landa & Arriaga, 2017}; OECD, 1998).

Several reforms to the economic system were implemented to promote the open economy model in Latin America, which were aimed at: (i) eliminating effective trade protection through the dismantling of tariff brackets and average and maximum tariffs, eliminating import permits/licenses, incorporating anti-dumping measures, and establishing countervailing and customs duties; (ii) broadening taxation schemes and restructuring government spending, as well as an intense process of privatization of public companies; (iii) disincorporating and eliminating restrictions on foreign participation; iv) standardizing and regulating the provisions of the guarantee, savings, capitalization, and insolvency regimes; v) eliminating interest rate controls; vi) making the exchange rate regime more flexible, synchronized with capital movements, and granting autonomy to the monetary authority; vii) adjusting (reformulating) the foreign direct investment law; and viii) adapting the labor market and pension system legislation. It is surmised that the symbiosis of these elements would boost output and economic development in the long term.

The operation of the open economy model (OEM) in Latin America has generated heterogeneous results. The characteristic feature of this stage has been the development of output, which continues to expand slowly, in addition to a significant contraction in productivity and the stagnation of both investment and local technological activity (see Table 1). A relevant contrast is the sustained expansion of economic activity in Southeast Asia, where average annual growth between 1990 and 2018 in China, Indonesia, or Singapore reached 9.7%, 4.8%, and 5.7%, respectively.

On the other hand, economic liberalization has enabled Latin American countries to increase exports and FDI inflows substantially. However, it has also led to rapid growth in imports, particularly of intermediate and capital goods, due to the high content of foreign value added in export production, a situation that has created significant pressure on the trade balance, essentially associated with the systematic imbalance of the external account of the manufacturing sector, with the compensating effect of the agricultural and mining-extractive surplus being insufficient for some countries.

Specialization in primary products, as well as in industries with low added value (intermediate stages of global value chains), helps explain the vulnerability of the dynamic gains associated with trade and FDI, among other aspects, because product differentiation is not the engine of competitiveness to the extent that the corporate strategies of transnational companies (TNCs) are focused on the exploitation of natural resources or the establishment of export platforms.

Indeed, price stability, debt containment, and fiscal consolidation represent the symbolic result of the OEM, see Table (2). With the implementation of the inflation targeting policy, within the framework of the new macroeconomic consensus (NCM), not only did the interest rate become the mechanism for adjusting inflation differentials, but it also required the adoption of a structural balance fiscal policy and, therefore, controlled management of the external and domestic liabilities of the countries in Latin America, which in symbiosis have made it possible to stop the systematic contraction of purchasing power and the vulnerability of public finances.

Regarding financial intermediation and market capitalization, the results generally are dissimilar to the values expected from the financial deregulation carried out in Latin America. On the one hand, the conditions of zero growth in the savings rate of significant thresholds and the reconversion of the structure of credit provided by commercial banks, oriented by the short-term profits that household and public sector financing provides, seem to impose significant credit restrictions to stimulate the degree of liquidity of the companies. On the other hand, although the value of stock market capitalization has risen visibly in Latin America over the last three decades, the persistent concentration in a small group of large companies and low stock turnover reduce the dynamic gains associated with stock market consolidation. Undoubtedly, the evolution of the stock market system is significant since its consolidation not only reflects the degree of strength of the financing, investment, and hedging operations of the production sector but also constitutes a reference for the capital and exchange markets since it provides relevant information on the profitability of the financial system to the process of formation and adjustment of the expectations of economic agents.

Similarly, reforms to foreign ownership controls and stock market hedging instruments allowed Latin American economies to substantially increase investment inflows (direct and portfolio) and the systematic accumulation of net foreign assets, which in macroeconomic terms, by establishing profitability expectations, improved country risk projections, increased liquidity, and reduced volatility in the exchange and capital markets; nevertheless, this accumulation of international reserves could, outside the optimal stock, create an extension of financial costs and financial asset prices, in addition to potential exchange rate losses (^{Rozo & Maldonado, 2018}; ^{Blancas, 2015}).

It should be noted that the operation of the single target monetary policy would require implementing a free-floating exchange rate system, in line with the fundamentals of the NCM, to mitigate the effects of external shocks and contribute to the profitability/stability of the financial system. Certainly, these transformations have succeeded in reducing exchange rate volatility in Latin American economies. Nonetheless, the exchange rate continues to depreciate (overvalue) in the long term, see Table 2.

Empirical analysis: The Latin American case

Conclusions

This paper has evaluated the financial system's contribution to the dynamics of output in Latin America during the period 1990-2017 through the analysis of the dynamic effects linked to financial structure and efficiency. Having reviewed the theoretical foundations and the variety of empirical results in the literature, the hypothesis testing of this research was based on an extension of the credit-constrained growth model of ^{Aghion and Howitt (2009)}, which, in addition to the implications of the financial sector and local technological capacity, incorporated the evolution of international trade and other control variables (FDI and capital formation).

The empirical evidence, first, confirms a direct relation between financial expansion and GDP expansion. Second, it shows that the impact of this link is reduced. The reason for this result lies in the conversion of the structure of bank credit, directed toward the financing of households and government instruments, as well as the significant concentration of stock market liquidity in a reduced group of companies and the low rotation of shares in the Latin American stock markets. Third, the regressions corroborated, in the sense of the axioms of the endogenous theory, the role of international trade in the expansion of output, through the phenomenon of technological externalities.

Given the above, institutional strengthening (among others: regulatory quality, government effectiveness, rule of law, or political stability) is an important condition for strengthening the network of incentives that, on the one hand, enable the transfer of liquidity/financing to the production sector and, thus, the consolidation of financial inclusion and, on the other hand, contribute to the attraction of long-term capital funds to the stock market.

Future research must include more robust indicators on profitability, performance, and financial structure, including institutional investors, and differentiate the analysis with different levels of disaggregation, such as comparative studies of economic blocs and by industry.