Finance-growth-poverty nexus: a re-assessment of the trickle-down hypothesis in China

Poverty has remained one of the prominent challenges of humanity. Different solutions have been suggested to curb poverty. Economic growth and financial development are two such crucial tools for overcoming poverty, as frequently pointed out by economists. These tools work through the so-called trickle-down hypothesis, which contends that a well-functioning financial system would enhance poverty reduction by promoting economic growth. One country that appears to have manifested this hypothesis is China. However, the empirical test of the trickle-down hypothesis for China is scant. In addition, most of the existing studies have failed to account for regime-shift in parameters or structural breaks. This paper attempts to fill this void by testing the trickle-down hypothesis for China during the period 1985–2014. We utilized two standard proxies for financial development, namely: the domestic credit to private sector by banks as percentage of GDP, and money and quasi money as percentage of GDP; annual percentage change in real GDP per capita to proxy economic growth; and a standard proxy for poverty reduction namely: the household final consumption expenditure per capita growth. By accounting for structural breaks in our empirical specifications, we found overwhelming support for the trickle-down hypothesis at the national level. That is, we found financial development to cause economic growth, which in turn causes poverty reduction in China at the national level. This has important policy implications.