The effects of financial inclusion on development outcomes: New insights from ASEAN and East Asian countries

Rajabrata Banerjeef Ronald Donato, and Admasn Afsaw Mavuta

3.1 Introduction

Over the past decade, financial inclusion has received increasing attention amongst researchers and policymakers, and a growing body of empirical literature is emerging highlighting the potential benefits of increasing financial inclusion in developing countries (Demirguy-Kunt et al., 2018; IEG, 2015; Allen et ah, 2012). The Sustainable Development Goals (SDGs) proposed by the United Nations refer to financial inclusion as a mechanism for supporting inclusive economic growth (Jahan et ah, 2019). In essence, financial inclusion is generally viewed as the extent of the population which has access to and use for formal financial services. In this context, research and policy attention have focused on those people who are socially excluded from the financial system and how strategies can be devised to enable the ‘unbanked’ segments of the population to enhance their engagement with the financial system. Expanding financial inclusion has the potential to benefit the poor through various channels, including the ability to accumulate savings and access credit that enable them to smoothen consumption patterns, better manage financial risk to deal with uncertainties, and invest in productive assets (Demirguy-Kunt et al., 2018; IEG, 2015).

The study reported here considers a comprehensive data set on financial inclusion and development outcomes from 20 Asian countries over the period 2004- 2015. This chapter builds on the previous chapter and contributes to the research enquiry on financial inclusion by filling several important research gaps in the literature. Specifically, they are (i) extending the array of development outcomes being analysed, (ii) using both aggregated and disaggregated measures of financial inclusion when determining its impact on development outcomes, (iii) giving greater attention to the role of political risk factors and its interaction effect when examining the impact of financial inclusion on development outcomes, and (iv) determining the broader policy implications that come with such closer examination. We briefly elaborate on these contributions in the pages that follow.

First, much of the empirical literature exploring the potential benefits of financial inclusion on development outcomes has focused on economic growth, poverty, and income inequality where research findings generally reveal the positive effects of financial inclusion on these outcomes (e.g., see Chapter 2). However, there is a dearth of empirical literature examining the effect of financial inclusion on other important development outcomes listed under SDGs and forming part of overall human development - specifically, health and education outcomes. This is surprising given the already-established positive nexus in the empirical literature between financial development and human capital and its impact on education and health outcomes. Accordingly, a key focus of this chapter is to extend the range of development outcomes under analysis by examining the impact of financial inclusion on economic growth, education, health, and income inequality. The aim is to offer greater insight and understanding into the extent to which financial inclusion impacts on particular development outcomes relative to others. This is particularly important from a policy perspective as the effect of financial inclusion on certain economic development outcomes may be stronger than others (e.g., health vs education vs poverty, etc.), which may vary across regions based on their demographic and institutional characteristics.

The second contribution of this chapter is that both aggregated and disaggregated measures of financial inclusion are incorporated into the analysis to discern a more nuanced understanding of how financial inclusion at a broader level and on an individual level impacts on development outcomes. Thus far, all empirical research on financial inclusion have either adopted an aggregate measure of financial inclusion by way of developing composite index measures (e.g., see Sarma, 2008; Park and Mercado, 2015, 2018) to analyse its impact, or studies have selected specific financial indicators (e.g., number of bank branches, number of automatic teller machines, deposit accounts), drawn from either an access or a usage component of the financial system, as a proxy measure of financial inclusion (e.g., Neaime and Gaysett, 2018; Demirgu?-Kunt and Klapper, 2012; Honohan, 2008). It is generally understood both in the construction of a composite financial index measure and in utilising individual indicators that financial inclusion, as noted in Chapter 2, is generally referred to as comprising three major dimensions or components - namely, usage, access, and quality (see Jahan et al., 2019). To date, the empirical literature has given very limited attention to the nexus between these three levels of aggregation, that is, composite index measure, dimensions, and indicators. Accordingly, and in contrast to other studies, this study uses both an aggregated and a disaggregated approach to measure and analyse financial inclusion. Specifically, we first consider financial inclusion at an aggregate level by using a hybrid methodology to establish a financial inclusion index (reported in Chapter 2) and to empirically examine its relationship with development outcomes. We then disaggregate the index into three dimensions of financial inclusions, specifically access, usage, and quality, to examine whether specific dimensions are more strongly associated with particular development outcomes than others. Finally, we disaggregate further to the individual indicator level of financial inclusion and examine the effect of the top two most influential indicators from each dimension, based on principal component analysis scores reported in the previous chapter, on the various development outcomes to see whether the impact of financial inclusion is sensitive to specific indicators. It is important to note here that we do not claim to establish all possible channels through which these indicators influence economic development, which would require a more rigorous empirical investigation at the country level and beyond the scope of this study. However, we show that the effect of financial inclusion is sensitive to the type of indicator chosen.

Related to this, as a third contribution, this study refers to the growing body of literature on institutional quality and examines how political factors mediate the effect of financial inclusion on economic growth, education, health, and income inequality. The importance of institutional quality for economic development is well established in the literature (see, e.g., Rodrik et al. 2004; Shleifer and Vishny, 1993; Gupta et al., 2001; Justino et al., 2013; Akresh et al., 2012). Also, a growing body of literature argues that if a country has lower political risk factors, the effect of financial inclusion is more immediate, such as ownership and usage of bank accounts and financial literacy (Allen et al., 2016; Grohmann et al., 2018). However, very little attention has been paid to how political factors moderate the effect of financial inclusion on various economic development outcomes.

The remainder of this chapter is structured as follows: Section 3.2 provides a brief overview of the literature on development outcomes. Section 3.3 describes the data, whilst Section 3.4 outlines the empirical methodology used in the analysis. Section 3.5 reports on the empirical findings and Section 3.6 concludes with discussion and policy implications.

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