1 Introduction
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One of the most comprehensive studies in terms of time period and the number of countries in the literature. The analysis is carried for 97 developing and developed countries in six different country groups for 28 years which also includes the time period after the 2008 financial crisis which most of the other papers do not capture. This helped to understand for each country group which factors are more important. All the countries with large contributions to global imbalances are added.
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Investigating the largest number of institutional factors in the longest time period related with the legal system, political system, political risks and stability, corruption behind current account balances for a panel of developed and developing countries which are identified by Bernanke (2005). New determinants, such as legal system and property rights, voice and accountability, political stability and absence of violence, political constraints which are represented with indexes, are identified. These factors are found to have negative and statistically significant relations for some of the country groups.
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Extending the set of factors.For the first time, inflation rate (CPI) representing macroeconomic stability (in the form of low inflation) factor which is identified by Bernanke (2005), is added to the study. Macroeconomic stability is found to have positive and statistically significant relations with current account balances for three country groups. One of the macroeconomic factors, net average crude oil export per GDP is used in the analysis to measure the direct effect of oil dependency instead of production or consumption. It is found to have positive and statistically significant relations with current account balances for five groups of countries.
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Financial market development (as measured by the share of private credit to GDP) is found to have overall negative and statistically significant relationships with current account balances for all country groups without exception for the first time in a study. Gruber and Kamin (2009) are unable to find consistently statistically significant impact with current account balance and financial development as measured by the share of private credit to GDP. They reach a conclusion that different quantity of measures of financial development including private credit neither appears to influence current account balances in the expected direction nor did they help explain the large developing country surpluses or the outsized US deficit. Legg et al. (2011) are unable to find statistically a significant relationship with current account balance and stock market turnover (financial deepness). Cheung et al. (2013) find a statistically significant impact with current account balance only for the full sample.
2 Assessing the factors of global current account balances
Variables | Number of observations | Data source | |
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Dependent variables | |||
1 | Current account/GDP (%) | 2936 | WEO |
Macroeconomic determinants | |||
2 | GDP (%) | 3111 | World Bank |
3 | Terms of trade | 2363 | World Bank |
4 | Real effective exchange rate | 3132 | Bruegel Think Tank |
5 | Trade openness (X + M)/GDP (%) | 3079 | World Bank |
6 | Average net crude oil export/GDP (%)a | 2457 | EIA, World Bank |
7 | Government expenditures/GDP (%) | 3062 | World Bank |
8 | Fiscal balance/GDP (%) | 2012 | World Bank, OECD |
9 | Relative income (US = 1) | 3139 | World Bank |
Demographics determinants | |||
10 | Old-age dependency ratio (%) | 3385 | World Bank |
11 | Youth dependency ratio (%) | 3385 | World Bank |
Macroeconomic stability determinant | |||
12 | Inflation rate (CPI) | 3031 | WEO |
Financial determinants | |||
13 | Total private credit/GDP (%) | 2945 | World Bank |
14 | Stock market capitalization/GDP (%) | 1984 | World Bank |
15 | Market turnover/GDP (%) | 1957 | World Bank |
Institutional determinants | |||
16 | Legal system and property rights index | 1493 | Fraser Institute |
17 | Regulation index | 1492 | Fraser Institute |
18 | Political constraint (Polcon V) index | 2942 | POLCON |
19 | Voice and accountability index | 1536 | World Bank |
20 | Control of corruption index | 1552 | World Bank |
21 | Political stability and absence of violence index | 1552 | World Bank |
22 | Regulatory quality index | 1552 | World Bank |
23 | Rule of law index | 1552 | World Bank |
24 | Economic freedom summary index | 1492 | Fraser Institute |
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Real effective exchange rate Changes in the real effective exchange rate will affect the prices of the import and export goods with the country’s currency. Goods will be relatively more expensive or cheaper which have a positive or negative impact on the current account balances. The Marshall Lerner condition states that depreciation or devaluation of the exchange rate will eventually lead to a net improvement in the trade balance provided that the sum of the price elasticity of demand for exports and imports are greater than 1. So a negative relationship is expected between the real effective exchange rate and current account balances. Many countries are still using fixed or managed floating exchange rate regimes. Some countries (such as China) have undervalued their exchange rate to increase the amount of export to promote growth. European Union countries since they all use the same currency, and they do not individually have control over the value of the Euro. When the euro is overvalued especially developing countries of EU could suffer on current account balances. Legg et al. (2011) add real effective exchange rate into their analyses and see that model appears to improve for several regions for particular periods. Cheung et al. (2013) find that the real effective exchange rate is one of the cyclical factors part of the narrowing the current account balances. Aristovnik (2006) finds an appreciation of the real exchange rate deteriorates the current account deficit.
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Terms of trade This is the ratio of export to import prices. Only the prices of tradeable goods are included in terms of trade. Changes in terms of trade will affect the amount of national savings and will have a positive or negative impact on the current account balance of a country. There are many fluctuations in small open economies because small economies can be easily disturbed by external shocks through international trade. Harberger (1950), Laursen and Metzler (1950) suggests that a reduction in current income arising from a terms of trade shock would decrease both private savings and the current account balance. Meeting the conditions of Harberger, Laursen and Metzler effect means income effect caused by the terms of trade degradation will reduce current income and total savings and this will eventually cause the deterioration of the current account balance. Developing countries which are unable to produce and export high technology goods expected to run higher current account deficits. Debelle et al. (1996) find that terms of trade have short-run effects on the current account balance. Aristovnik (2006) finds that worsening terms of trade generate a deterioration of the current account deficit.
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Demographics Demographic variation may be an important factor in national savings which may explain the differences in current accounts across countries. The life-cycle hypothesis suggests that the saving behaviour of households varies with age. As a result, countries with a relatively high percentage of young and elderly households would tend to run current account deficits. So based on the life-cycle hypothesis negative relationship is expected between demographic variables and current account balances. The main variables tested include youth and old-age dependency ratios. Legg et al. (2011) find that demographic factors have a significant impact on a nation’s current account balance.
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Fiscal balance A rise in the public deficit can reduce national savings without a Ricardian offset from private savings and may increase current account deficits. A positive relationship is expected. In most of the studies, a positive relationship between fiscal balances and current account balances has been found. Also the effect of budget deficits on current account balances may be related with how fiscal expenditures are allocated. Chinn and Prasad (2003) find that the current account balances are positively correlated with government budget balances.
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Stage of economic development Standard neoclassical theory suggests that developing countries with low capital–labour ratios will import capital from developed countries and run current account deficits. The stages of development hypothesis suggest that countries when they reach an intermediate stage of development from a low stage of development, they begin to import capital and run current account deficits. As they become a more developed economy, countries start to run current account surpluses to pay off external debts. Eventually, they begin to export capital to developing economies. In the years before the global financial crisis, the opposite pattern has been observed for capital flows. Lucas (1988) explains that capital flows to developing countries have been less than expected because of domestic distortions that lower the risk-adjusted returns to capital. These distortions may be related with under-developed financial markets or weak institutions, and this may explain why financial capital tends to flow to developed countries instead of developing countries. A negative or positive relationship can be expected based on the validity of the neoclassical theory or Lucas (1988) paradox. Negative relationship supports Lucas Paradox. Positive relationship supports the neoclassical theory. The variable used to represent the stage of economic development is the relative (USA = 1) income per capita. Cheung et al. (2013) find the stage of development as one of the structural factors of current accounts.
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Level of financial development A common explanation for widening current account balances is that some of the developing countries have exported their excess capital to countries with more developed financial markets (Ju and Wei 2006). Moreover, the financial development could also encourage consumption and decrease the saving rates. If these explanations are true, improved financial deepening could reduce saving rates in these economies, and could cause a negative relationship between financial development and current account balances. An alternative opposite effect can be considered. Generally, financial market development has been considered to encourage savings by reducing transaction costs and facilitating risk management. This will cause a positive effect on the saving rates and also on the current account. Empirical results are mixed, and it depends on the set of countries and variables that are used to proxy financial deepness. The variables tested are (i) private credit as a share of GDP; (ii) stock market capitalization as a share of GDP; (iii) stock market turnover as a share of GDP.
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Quality of institutions Bernanke (2005) suggests to help developing countries to re-enter international capital markets as borrowers instead of lenders. Developing countries could improve their investment climates by continuing to raise macroeconomic stability, decrease corruption, strengthen property rights, and allow the flow of financial capital. One of the explanations for Lucas paradox of capital flowing to developed countries instead of developing countries is, weak institutions decrease the risk-adjusted return to capital in developing countries (Alfaro et al. 2005). So when the quality of institutions and macroeconomic stability are improved, current account deficits will increase. So based on that negative relationship is expected between the quality of institutions and current account balances, nine variables for the quality of institutions are added to the study.
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Macroeconomic stability Bernanke (2005) suggests that developing countries improve their investment climate by continuing to increase macroeconomic stability. CPI is added to this study. If inflation is low more financial capital out of the country will enter the country which will cause to increase the current balance deficit. Odedokun (2003) finds in his study, a stable macroeconomic environment in the form of low inflation and low monetary expansion is an important determinant for attracting foreign private capital to developing countries for the investors in a capital-exporting country. So a positive relationship is expected between macroeconomic stability and current account balances for developing countries.
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Oil dependency On the current account balance, it is important if a country is a net exporter or a net importer of crude oil. The impact on current account balances would then change with how much a country uses oil in its economy as an importer, or with the relative importance of oil production in its economy as an exporter. The variable used to indicate a country’s oil intensity or dependency is the net average crude oil export per GDP. Several variables were used until now, but the average crude oil export variable is the most direct way to measure the dependency. A positive relationship is expected between average net crude oil and current account balances. Cheung et al. (2013) find that oil dependency and intensity is one of the structural factors of current account balances.
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Growth Countries with high labour productivity growth may attract foreign capital flows because they are expected to produce higher rates of return. Also when emerging countries grow faster, it will cause more intermediate goods and machinery investment import which will cause higher current balance deficits. This higher current balance deficit means a negative relationship between growth and current account balances. For developed countries, the opposite may be expected to happen. With higher growth rates they may export more high technology goods which will have a positive effect on current account balances. The real GDP growth rate is used in the study. Calderon et al. (2002) find that a rise in domestic output growth generates larger current account deficits.
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Trade openness Widening current account positions could result in part from increasing globalization, which increases cross-border trade and financial capital flows. A country’s degree of openness to international trade, measured as total exports and imports as a share of GDP, could also reflect industrial policy choices, including tariff regimes. Developing countries which are highly open to international trade may run higher current account deficits since they have to import a lot of intermediate goods and machinery from developed countries. The negative relationship can be expected for most of the developing countries. Chinn and Prasad (2003) find that trade openness is negatively correlated with current account balances.
3 Data and methodology
3.1 Data and model
3.2 Econometric methodology
4 Results
Industrial | High income | Developing | Full sample - | Full sample - | Full sample | |
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Industrial | Africa and Industrial | |||||
GDP | .1631 | − .1152 | .0043 | − .0883 | − .1259 | − .0653 |
(2.27)** | (− 2.19)** | (.07) | (− 1.69)* | (− 1.81)* | (− 1.36) | |
Fiscal balance/GDP | .0111 | .1766 | .3302 | .3394 | .1763 | .3197 |
(.07) | (1.52) | (3.39)*** | (3.59)*** | (1.92)* | (3.68)*** | |
Terms of trade | .0549 | .0244 | .1118 | .0818 | .0576 | .0793 |
(1.72)* | (1.60) | (5.47)*** | (4.73)*** | (2.58)** | (4.85)*** | |
Real effective exchange rate | − .0669 | − .0502 | − .1345 | − .1057 | − .1028 | − .1049 |
(− 1.47) | (− 2.98)*** | (− 4.00)*** | (− 4.26)*** | (− 3.48)*** | (− 4.49)*** | |
Trade openness | − .0410 | − .0085 | − .1789 | − .0921 | − .0584 | − .0884 |
(− .90) | (− .42) | (− 5.00)*** | (− 3.70)*** | (− 2.32)** | (− 3.77)*** | |
Relative income | − 27.9918 | − 18.6167 | − 187.4111 | − 17.9461 | − 16.0701 | − 17.1117 |
(− 2.34)** | (− 2.03)** | (− 2.88)*** | (− 1.15) | (− .82) | (1.68)* | |
Average net crude oil export/GDP | .4006 | .6631 | .6314 | .6580 | .8318 | .6543 |
(1.28) | (3.08)*** | (4.43)*** | (4.61)*** | (3.75)*** | (4.65)*** | |
R-sq | .0913 | .1335 | .3319 | .2720 | .1999 | .2540 |
Number of observations | 285 | 529 | 754 | 997 | 761 | 1282 |
4.1 Baseline specification: macroeconomic determinants
4.2 The role of financial development, macroeconomic stability and institutional quality
Industrial | High income | Developing | Full sample - | Full sample - | Full sample | |
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Industrial | Africa and Industrial | |||||
GDP | .1515 | − .0682 | − .0088 | − .0796 | − .1111 | − .0582 |
(1.95)* | (− 1.48) | (− .13) | (− 1.50) | (− 1.59) | (− 1.19) | |
Fiscal balance | − .0195 | .1070 | .3179 | .3212 | .1390 | .3043 |
(− .12) | (.96) | (3.32)*** | (3.45)*** | (1.53) | (3.53)*** | |
Terms of trade | .0448 | .0156 | .1082 | .0798 | .0574 | .0764 |
(1.29) | (1.02) | (5.29)*** | (4.61)*** | (2.57)** | (4.60)*** | |
Real effective exchange rate | − .0697 | − .0625 | − .1310 | − .1086 | − .1102 | − .1075 |
(− 1.50) | (− 3.66)*** | (− 3.79)*** | (− 4.36)*** | (− 3.78)*** | (− 4.57)*** | |
Trade openness | − .0649 | − .0155 | − .1762 | − .0926 | − .0588 | − .0893 |
(− 1.37) | (− .74) | (− 4.92)*** | (− 3.70)*** | (− 2.34)** | (− 3.78)*** | |
Relative income | − 25.2878 | − 15.5177 | − 177.0909 | − 11.7724 | − 8.7412 | − 12.9486 |
(− 1.98)** | (− 1.67)* | (− 2.72)*** | (− .78) | (− .49) | (− 1.25) | |
Average net crude oil | .0648 | .5471 | .6198 | .6493 | .8169 | .6431 |
Export/GDP | (.18) | (2.58)*** | (4.31)*** | (4.52)*** | (3.55)*** | (4.53)*** |
Total private credit/GDP | − .0360 | − .0247 | − .0556 | − .0303 | − .0240 | − .0319 |
(− 2.96)*** | (− 3.88)*** | (− 2.01)** | (− 2.92)*** | (− 2.67)*** | (3.84)*** | |
R-sq | .1308 | .1324 | .3356 | .2754 | .1994 | .2595 |
Number of observations | 259 | 494 | 753 | 987 | 752 | 1246 |
Industrial | High income | Developing | Full sample - | Full sample - | Full sample | |
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Industrial | Africa and Industrial | |||||
GDP | .1284 | − .0717 | − .0047 | − .0756 | − .1202 | − .0544 |
(1.84)* | (− 1.75)* | (− .07) | (− 1.40) | (− 1.82)* | (− 1.09) | |
Fiscal balance | − .0563 | − .2192 | .2912 | .2971 | .1505 | .2810 |
(− .38) | (− 1.53) | (3.34)*** | (3.39)*** | (1.68)* | (3.46)*** | |
Terms of trade | .0560 | .0261 | .1011 | .0738 | .0578 | .0707 |
(1.60) | (1.56) | (5.16)*** | (4.40)*** | (2.55)** | (4.39)*** | |
Real effective exchange rate | − .0831 | − .0460 | − .1103 | − .0932 | − .1108 | − .0929 |
(− 2.00)** | (− 2.94)*** | (− 4.36)*** | (− 5.04)*** | (− 3.84)*** | (− 5.27)*** | |
Trade openness | − .0223 | .0019 | − .1990 | − .1034 | − .0542 | − .0994 |
(− .52) | (.10) | (− 5.51)*** | (− 4.04)*** | (− 2.29)** | (− 4.12)*** | |
Relative income | − 16.2272 | − 28.3194 | − 194.3722 | − 13.4536 | − 8.0804 | − 14.0832 |
(− 1.27) | (− 2.95)*** | (− 3.01)*** | (− .87) | (− .46) | (− 1.34) | |
Average net crude oil export/GDP | − .3252 | .7246 | .5610 | .5876 | .8262 | .5805 |
(− .79) | (4.62)*** | (4.21)*** | (4.38)*** | (3.62)*** | (4.38)*** | |
Total private credit/GDP | − .0315 | − .0195 | − .0567 | − .0305 | − .0241 | − .0323 |
(− 2.73)*** | (− 3.23)*** | (− 2.10)** | (− 2.97)*** | (− 2.67)*** | (− 3.90)*** | |
Inflation rate (CPI) | − .4638 | .0000 | .0118 | .0117 | − .0188 | .0118 |
(− 2.72)*** | (.11) | (36.42)*** | (40.45)*** | (− .95) | (41.31)*** | |
R-sq | .1797 | .2457 | .4385 | .3632 | .2013 | .3428 |
Number of observations | 259 | 611 | 744 | 978 | 750 | 1237 |
Industrial | High income | Developing | Full sample - | Full sample - | Full sample | |
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Industrial | Africa and Industrial | |||||
GDP | .1393 | − .0759 | .0161 | − .0815 | − .1150 | − .0603 |
(1.74)* | (− 1.59) | (.31) | (− 1.51) | (− 1.63) | (− 1.21) | |
Fiscal balance | − .0441 | .1202 | .1990 | .3207 | .1247 | .3032 |
(− .27) | (1.02) | (2.09)** | (3.39)*** | (1.34) | (3.46)*** | |
Terms of trade | .0457 | .0196 | .0678 | .0837 | .0615 | .0801 |
(1.31) | (1.24) | (2.50)** | (4.81)*** | (2.76)*** | (4.79)*** | |
Real effective exchange rate | − .0751 | − .0571 | − .1195 | − .1083 | − .1065 | − .1074 |
(− 1.37) | (− 2.94)*** | (− 5.12)*** | (− 4.25)*** | (− 3.57)*** | (− 4.43)*** | |
Trade openness | − .0510 | − .0179 | − .1197 | − .1034 | − .0682 | − .0977 |
(− 1.09) | (− .71) | (− 3.98)*** | (− 3.83)*** | (− 2.33)** | (− 3.84)*** | |
Relative income | − 29.6275 | − 13.6657 | − 214.1652 | − 10.7705 | − 6.1277 | − 13.2496 |
(− 2.30)** | (− 1.42) | (− 3.44)*** | (− .68) | (− .33) | (− 1.21) | |
Average net crude oil export/GDP | .1267 | .5266 | .4277 | .6448 | .7978 | .6390 |
(.34) | (2.30)** | (3.67)*** | (4.56)*** | (3.41)*** | (4.55)*** | |
Total private credit/GDP | − .0326 | − .0208 | − .0676 | − .0277 | − .0209 | − .0290 |
(− 2.77)*** | (− 3.66)*** | (− 2.54)** | (− 2.88)*** | (− 2.82)*** | (− 3.70)*** | |
Polcon V | − .4662 | − 3.1961 | − 1.5152 | − 1.8629 | − 2.5681 | − 1.8285 |
(− .29) | (− 1.74)* | (− 1.23) | (− 1.57) | (− 1.96)* | (− 1.60) | |
R-sq | .1281 | .1340 | .3370 | .2822 | .2083 | .2659 |
Number of observations | 242 | 452 | 750 | 960 | 725 | 1202 |
Industrial | High income | Developing | Full sample - | Full sample - | Full sample | |
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Industrial | Africa and Industrial | |||||
GDP | .1797 | − .0296 | .1082 | .01332 | − .0337 | .0393 |
(2.29)** | (− .60) | (1.31) | (.19) | (− .39) | (.64) | |
Fiscal balance | − .0623 | .1841 | .2529 | .2674 | .1454 | .2532 |
(− .36) | (1.48) | (1.85)* | (2.12)** | (1.33) | (2.28)** | |
Terms of trade | .0372 | .0028 | .0947 | .0650 | .0573 | .0605 |
(1.04) | (.16) | (4.39)*** | (3.36)*** | (2.94)*** | (3.34)*** | |
Real effective exchange rate | − .0552 | − .0398 | − .1344 | − .1074 | − .1091 | − .1035 |
(− 1.12) | (− 1.04) | (− 4.32)*** | (− 3.35)*** | (− 2.71)*** | (− 3.78)*** | |
Trade openness | − .0729 | − .0113 | − .2254 | − .1006 | − .0677 | − .0951 |
(− 1.35) | (− .50) | (− 4.47)*** | (− 2.76)*** | (− 1.82)* | (− 2.91)*** | |
Relative income | − 29.4922 | − 7.6128 | − 63.9564 | 18.5286 | 16.7302 | − .2062 |
(− 2.01)** | (− .82) | (− .60) | (1.26) | (1.29) | (− .02) | |
Average net crude oil export/GDP | − .0303 | .5128 | .5694 | .6172 | .8676 | .6048 |
(− .08) | (2.00)** | (3.57)*** | (3.88)*** | (3.00)*** | (3.92)*** | |
Total private credit/GDP | − .0444 | − .0265 | − .0918 | − .0285 | − .0262 | − .0327 |
(− 3.27)*** | (− 3.67)*** | (− 2.61)** | (− 2.44)** | (− 2.87)*** | (− 2.67)*** | |
Political stability and absence of violence | .2175 | − .3655 | − 1.3520 | − 1.3147 | − 2.0465 | − 1.1350 |
(.29) | (− .48) | (− 1.44) | (− 1.67)* | (− 2.11)** | (− 1.72)* | |
R-sq | .1641 | .0953 | .3621 | .2595 | .2100 | .2380 |
Number of observations | 226 | 399 | 447 | 619 | 485 | 845 |
Full sample - | Full sample - | Full sample - | Full sample - | |
---|---|---|---|---|
Africa and industrial | Africa and industrial | Africa and industrial | Africa and industrial | |
GDP | − .1407 | − .1150 | − .0337 | − .0354 |
(− 3.60)*** | (− 1.63) | (− .39) | (− .42) | |
Fiscal balance | .1005 | .1247 | .1454 | .1332 |
(.88) | (1.34) | (1.33) | (1.24) | |
Terms of trade | .0294 | .0615 | .0573 | .0558 |
(1.96)** | (2.76)*** | (2.94)*** | (2.84)*** | |
Real effective exchange rate | − .0777 | − .1065 | − .1091 | − .1109 |
(− 4.18)*** | (− 3.57)*** | (− 2.71)*** | (− 2.84)*** | |
Trade openness | − .0362 | − .0682 | − .0677 | − .0663 |
(− 1.70)* | (− 2.33)** | (− 1.82)* | (− 1.85)* | |
Relative income | 7.9815 | − 6.1277 | 16.7302 | 14.1593 |
(.62) | (− .33) | (1.29) | (1.09) | |
Average net crude oil export/GDP | .5975 | .7978 | .8676 | .8906 |
(2.59)*** | (3.41)*** | (3.00)*** | (3.17)*** | |
Total private credit/GDP | − .0230 | − .0209 | − .0262 | − .0273 |
(− 2.68)*** | (− 2.82)*** | (− 2.87)*** | (− 3.23)*** | |
Political stability and the absence of violence 220132013) | − 2.0465 | |||
(− 2.11)** | ||||
(1996–2013) | ||||
Legal system and property rights (1990–2013) | − .7381 | |||
(− 2.03)** | ||||
Polcon V (1986–2013) | − 2.5681 | |||
(− 1.96)* | ||||
Voice and accountability (1996–2013) | − 5.0551 | |||
(− 2.08)** | ||||
R-sq | .1573 | .2083 | .2100 | .2150 |
Number of observations | 500 | 725 | 485 | 485 |