Abstract:

The existence of a relationship between short-term fluctuations or economic volatility and economic growth has essential macroeconomic and regional development policy implications, as it suggests the possibility that policies designed to stabilize short-term fluctuations might also have effects on the long-term performance of the economy. Depending mainly on whether this relationship is negative or positive, there is the presumption that successful stabilization would also entail either an improvement or deterioration in growth prospects. This paper aims to provide the general empirical evidences on regional economic volatility’s impact on regional economic growth in China. Based on the panel data set of 28 provinces in Chinese mainland over the period from 1978 to 2007 and on the cross-sectional data, using the corresponding econometric methods, we find that: (1) There is a robust negative relationship between regional economic volatility and regional economic growth in both temporal and spatial dimensions, although the magnitude of this negative effect is decreasing with the deepening of China’s reform and opening-up. Specifically, during 1978-1993, one percent increase of economic volatility would lead to the decrease of economic growth rate by 0.024%, while it only led to the decrease of 0.020% between 1994-2007 in our one way fixed effect panel data models. (2) The advancing process of financial and market-oriented development alleviates the negative effect imposed by economic volatility on long-term growth and the heterogeneous effect of volatility on growth in different regions caused by different levels of regional financial development and market-oriented development differs only in magnitude. This also shows the robust negative relationship between economic volatility and the growth in the spatial dimension. (3) In the Schumpeterian Waves analysis, we find strong evidence to reject the hypothesis that economic volatility is exogenous, and we use the fixed effect two stage least square method proposed by Keane and Runkle to capture the true impact of economic volatility on economic growth. Once we account for simultaneous and reverse causation in the economic volatility-growth relationship, the negative effect is magnified to a large extent. As a matter of fact, in the financial models, without considering the nonlinear effect of financial development, one percent increase of economic volatility will decrease the economic growth rate by 0.125%. Therefore, implementation of stable macroeconomic and regional development policies is beneficial to the long-term economic growth, especially in China.

Key words: China, financial deepening, long-term economic growth, market-oriented reform, panel data models, volatility