Finance-growth Nexus in China: A Channel Decomposition Analysis

This study aims to reassess the finance-growth nexus debate in China, and consequently illustrate the channels through which financial development gives impact on China’s economic growth after 1978. Specifically, this study addresses two channels through which the effects operate, i.e., physical capital accumulation and productivity improvement. The study adopts an approach called channel decomposition which combines the conventional accounting framework and regression analysis. The empirical analysis, using a panel dataset of Chinese provinces between 1980 and 2004, argues that: (1) the relationship between financial development and economic growth in China tends to be a long-run one; (2) the direction of causality between financial development and economic growth has presumably run from the former to the latter in China; (3) the impacts induced by various measures of financial system exert on economic growth are different, and the channels through which they give impact on the growth are different as well; (4) the existence of inter-regional heterogeneity in the context of China’s finance-growth nexus tends to be sensitive to the selection of financial variables.