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MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS HO CHI MINH CITY --------------- Pham Thi Thuy Diem OPENNESS, FINANCIAL DEVELOPMENT, ECONOMIC GROWTH, AND ENVIRONMENTAL QUALITY: EVIDENCE FROM DEVELOPING COUNTRIES DOCTOR OF PHILOSOPHY THESIS IN ECONOMICS Ho Chi Minh City, 2022 MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS HO CHI MINH CITY --------------- Pham Thi Thuy Diem OPENNESS, FINANCIAL DEVELOPMENT, ECONOMIC GROWTH, AND ENVIRONMENTAL QUALITY: EVIDENCE FROM DEVELOPING COUNTRIES Major: Development Economics Code: 9310105 ACADEMIC ADVISOR: Prof. Nguyen Trong Hoai Ho Chi Minh City, 2022 i COMMITMENTS I declare that the thesis has been composed by myself and that the thesis has not been submitted for any other degree or professional qualification. I confirm that the thesis submitted is my own, except where thesis which has formed part of jointly authored publications has been included. My contribution and those of the other authors to this thesis have been explicitly indicated below.

I confirm that appropriate credit has been given within this thesis where reference has been made to the work of others. Some works demonstrated in Chapter 1, Chapter 2, Chapter 3, Chapter 4, and Chapter 5 were previously published in an international journal, Cogent Economics & Finance, 9(1) as “Impacts of openness on financial development in developing countries: Using a Bayesian model averaging approach” by Pham Thi Thuy Diem (the first and corresponding author) & Nguyen Trong Hoai (co-author) (2021). The rest of works demonstrated in Chapter 1, Chapter 2, Chapter 3, Chapter 4, and Chapter 5 can be combined into two papers for further publications. The work presented in Chapter 2 was previously published in three national publications including: (i) Tạp chí Phát triển & Hội Nhập, 55(65), 109-116 as “Financial development and economic growth: A review of the literature” by Pham Thi Thuy Diem (the first and corresponding author) & Nguyen Trong Hoai (co- author) (2020); (ii) Tạp chí Công Thương, Số 1-Tháng 1/2021, 72-80 as “Trade openness and environmental quality: A review of the literature” by Pham Thi Thuy Diem (the first and corresponding author) & Nguyen Trong Hoai (co-author) (2021); (iii) Review of Finance, 4(1), 9-12 as “Impacts of openness on financial development: A review of the literature” by Pham Thi Thuy Diem (the first and corresponding author) & Nguyen Trong Hoai (co-author) (2021).

ii The thesis has been done under the supervision of Professor. Nguyen Trong Hoai, the University of Economics Ho Chi Minh City. Pham Thi Thuy Diem 10 July 2022 iii TABLE OF CONTENTS COVER PAGE COMMITMENTS TABLE OF CONTENTS ABBREVIATIONS LIST OF TABLES LIST OF FIGURES ABSTRACT CHAPTER 1 - INTRODUCTION .1 The impacts of openness on financial development .2 The impact of financial development on economic growth .6 The impact of trade openness on environmental quality. Structure of the thesis .14 CHAPTER 2 - LITERATURE REVIEW.

Openness and financial development. Impacts of openness on financial development: A theoretical review. Impacts of openness on financial development: An empirical review. Impacts of openness on financial development: Research hypotheses and a conceptual framework.

Financial development and economic growth. Impact of financial development on economic growth: A theoretical review. Impact of financial development on economic growth: An empirical review. Impact of financial development on economic growth: Research hypothesis and a conceptual framework.

Trade openness and environmental quality. Impact of trade openness on environmental quality: A theoretical review. Impact of trade openness on environmental quality: An empirical review. Impact of trade openness on environmental quality: Research hypothesis and a conceptual framework.

An integrated conceptual framework for the links between openness, financial development, economic growth, and environmental quality in developing countries .58 CHAPTER 3 - RESEARCH METHODOLOGY .60 The issue of model uncertainty .60 Bayesian model averaging methodology and model uncertainty. Construction of variables. Openness, financial development, economic growth, and environmental quality .99 v CHAPTER 4 - OPENNESS, FINANCIAL DEVELOPMENT, ECONOMIC GROWTH AND ENVIRONMENTAL QUALITY - EVIDENCE FROM DEVELOPING COUNTRIES. The impacts of openness on financial development: Evidence from developing countries.

Descriptive statistics results. Estimation results and discussions. The impact of financial development on economic growth: Evidence from developing countries. Descriptive statistics results.

Estimation results and discussions. The impact of trade openness on environmental quality: Evidence from developing countries. Descriptive statistics results. Estimation results and discussions .140 The impacts of openness on financial development: Evidence from developing countries.140 The impact of financial development on economic growth: Evidence from developing countries.

The impact of trade openness on environmental quality: Evidence from developing countries. Overall conclusions, limitations, and further research of the thesis. Limitations and further research. 181 vii ABBREVIATIONS AREAER Annual report on Exchange Arrangements and Exchange Restrictions BMA Bayesian model averaging BRIC Benchmark prior CO2 Carbon dioxide EG Economic growth FD Financial development FDI Foreign direct investment FO Financial openness GDP Gross Domestic Product GFDD Global Financial Development Database IEA International Energy Agency KAOPEN Capital account openness index LEB Local empirical Bayes approach PWT Penn World Table SO2 Sulfur dioxide TradeOpen Trade openness UIP Unit Information Prior UNCTAD United Nations Conference on Trade and Development WDI World Development Indicators WGI Worldwide Governance Indicators viii LIST OF TABLES Table 3.

Information on variables for Objective 1 72 Table 3. Information on variables for Objective 2 81 Table 3. Information on variables for Objective 3 92 Table 3. The list of developing countries 100 Table 4.

Summary statistics of the variables for Objective 1, whole sample, 64 104 economies, 2003-2017 Table 4. Correlations between of the variables for Objective 1, whole sample, 105 2003-2017 Table 4. The impacts of openness on financial development: posterior 109 estimates under uniform model priors Table 4. Summary statistics of the variables for Objective 2, whole sample, 64 117 economies, 2003-2017 Table 4.

Correlations between of the variables for Objective 2, whole sample, 118 2003-2017 Table 4. The impacts of financial development on economic growth: posterior 122 estimates under uniform model priors Table 4. Summary statistics of the variables for Objective 3, whole sample, 64 126 economies, 2003-2017 Table 4. Correlations between of the variables for Objective 3, whole sample, 130 2003-2017 ix Table 4.

The impacts of trade openness on environmental quality: posterior 133 estimates under uniform model priors x LIST OF FIGURES Figure 1. Financial development in developing countries over the period 4 2003-2017 Figure 1. Openness in developing countries over the period 2003-2017 5 Figure 1. Economic growth in developing countries over the period 2003- 7 2017 Figure 1.

Environmental quality in developing countries over the period 10 2003-2017 Figure 2. The McKinnon–Shaw model 16 Figure 2. A theoretical approach to openness and financial development 21 Figure 2. A conceptual framework for the impacts of openness on financial 31 development Figure 2.

A theoretical approach to financial development and economic 35 growth Figure 2. A conceptual framework for the impact of financial development 44 on economic growth Figure 2. A theoretical approach to trade openness and environmental quality 47 Figure 2. A conceptual framework for the impact of trade openness on 57 environmental quality Figure 2.

An integrated conceptual framework for three objectives 59 Figure 3. Legal origins of developing countries 101 xi Figure 4. Scatter plots of openness and financial development in developing 106 countries, 2003 – 2017 Figure 4. Marginal densities of trade openness, financial openness, and the 111 interaction between trade openness and financial openness from BRIC Figure 4.

Cumulative model probabilities from BRIC for Object 1 114 Figure 4. Scatter plots of financial development and economic growth in 119 developing countries, 2003 - 2017 Figure 4. Marginal densities of financial development from BRIC 124 Figure 4. Cumulative model probabilities from BRIC for Object 2 121 Figure 4.

Scatter plots of trade openness and environmental quality in 131 developing countries, 2003 – 2017 Figure 4. Marginal densities of openness from BRIC 135 Figure 4. Cumulative model probabilities from BRIC for Object 3 136 xii ABSTRACT Motivated by trade and financial liberalisation policies have become increasingly important in developing countries over the past two decades and the existing gaps in the literature regarding financial development, economic growth, and environmental quality research need to be addressed. Therefore, this thesis aims to provide new evidence on the impacts of trade and financial openness on financial development, the impact of financial development on economic growth, and the impact of trade openness on environmental quality in 64 developing countries over the period 2003-2017.

One major contribution of this thesis for three objectives is the adoption of the regression model based on Bayesian model averaging approach to consider model uncertainty (Raftery et al., 1997; Hoeting et, al., 1999; Chipman et al., 2001; Fragoso et al. Regarding the impacts of openness on financial development, the thesis demonstrates that the contribution of trade openness to financial development is important in developing economies with better institutions. However, financial openness has an insignificant positive effect on financial development. There is no evidence to support the Rajan and Zingales hypothesis that the simultaneous openness to both trade and capital flows promotes financial development.

The findings also indicate that a better institutions environment allows a developing economy to exploit the benefits of openness to financial development. Regarding the impact of financial development on economic growth, the main findings indicate that financial development has a significant U-shaped effect on economic growth, providing new insight concerning the relationship between financial development and economic growth in developing countries. The results also demonstrate that investment to gross domestic product ratio and foreign direct investment have significant positive effects on economic growth, whereas population growth has a significant negative impact on economic growth. xiii With regard to the impact of trade openness on environmental quality, the empirical results reveal that trade openness in developing countries does not cause environmental degradation.

Besides trade openness, the findings provide strong evidence in favour of financial openness and renewable energy consumption as two of the most important determinants of environmental quality by reducing carbon dioxide emissions. Meanwhile, inward FDI stock to domestic capital stock and income have harmful effects on environmental quality in the context of developing countries. Keywords: Openness, financial development, economic growth, environmental quality, developing countries, Bayesian model averaging. Research problems It is now widely accepted that trade and financial openness constitute potentially important mechanisms for financial development (Rajan and Zingales, 2003; Baltagi et al., 2007, 2009; Chinn and Ito, 2002, 2006; Law and Demetriades, 2006; David et al., 2014; Svaleryd and Vlachos, 2002, 2005; etc.) which in turn can influence economic growth, especially in developing countries (Caporale et al., 2014; Estrada et al., 2010, 2015; Menyah et al., 2014; Calderón and Liu, 2003; Bittencourt, 2012; Law and Singh, 2014; Rioja and Valev, 2004a, b).

Regarding trade openness, it could be one of the most crucial factors explaining environmental quality (Antweiler et al., 2001; Cole and Elliott, 2003; Managi et al., 2009; Atici, 2009, 2012; Baek et al., 2009; Nasir and Rehman, 2011; Shahbaz et al. Although there have been numerous investigations attempting to understand financial development, growth and environmental quality research, the majority of studies only utilised methodologies for panel data basing on traditional statistical inference (Gries et al., 2009; Chinn & Ito, 2002; Cecchetti & Kharroubi, 2012; Estrada et al., 2015; Zhang et al., 2012; Ergungor, 2008; Adu et al., 2013; Frankel & Rose, 2005; Antweiler et al., 2001; Cole & Elliott, 2003; Le et al. The standard statistical approaches ignore model uncertainty, leading to over-confident inferences, “all-or-nothing” constraint, and omitted variable bias that generalize poorly (Raftery, 1993; Raftery et al., 1997, 2005; Hoeting et al., 1999; Chipman et al., 2001; Fragoso et al., 2018, Hinne et al. Moreover, the competitive theories and empirical studies have remarkably emerged from the literature on financial development, growth and environmental quality determinants, which poses a significant challenge for development economics.

Therefore, Bayesian model averaging (BMA) is a tailor- made approach to deal with the model uncertainty that surrounds the large set of candidate regressors.