Financial Market Liberalization and Total Factor Productivity: A Panel Data Analysis

Abstract

Financial market liberalization refers to the gradual termination of regulatory controls over capital movements across countries. This study explores the effect of financial market liberalization on the total factor productivity (TFP) using data on 16 major Emerging Market Economies (EMEs) over the period 1997-2022. The generalized method of moments (GMM) technique of panel data estimation is employed involving different de-facto and de-jure capital market liberalization measures. The robustness of empirical results is checked by applying fixed effect and pooled OLS methods.  Our empirical findings suggest that foreign direct investment (FDI) is the only conspicuous de-facto measure affecting total factor productivity positively and significantly. However, one de-jure measure of capital market liberalization namely Schindler index is also found to be statistically significant. The core conclusion of this study is that foreign capital influx is the most advantageous when it arrives in the form of FDI. The institutions and macroeconomic governance are also imperative and play a catalytic role to harness the benefits from financial liberalization progression.