McKinnon’s Complementary Theory

Origin of the Theory:

In 1960s initial innovators, alike Goldsmith, Gerashchenko & Cameron castoff simple econometric techniques to discover about economics growth connection. They originate rough relations among monetary factors and production, but they did not deliver solid adequate theoretical basics to response the causation question.

 Ronald McKinnon (1973) & Edward Shaw (1973) gave their arguments about Financial Repression and came with the new concept of “Financial Liberalization” in economy. Financial repression mentions the idea about government rules and regulations, laws, and restrictions put by government about entry of financial sector of country that prevent them to perform per their capacity. The rules that result in financial repression contain capital controls interest rate maximums reserve requirements about liquidity ratios, ceiling credit allocation, government control of banks. Economists have frequently contended about financial repression that averts resourceful allocation of wealth and result in spoils economic growth.

Liberalization, exactly, means “elimination of regulates “When we conversation around financial liberalization, it means elimination of controls & limitations located on monetary area by central authority. Financial liberalization increased consideration in initial 1970s owing to seminal work by McKinnon (1973) & Shaw (1973) in which they contended that financial sector liberalization will result in huge savings, inspire investments & encourage economic development.

McKinnon & Shaw categorized financial repressed arrangement in which determines of government who contracts and stretches loan & at what amount involved. Government authority can work out and support such governor by changeable in which financial sector will allowable to organize operations and in what way they will allowed to work, by possessing banks and additional worldwide capital activities. Equally liberalization can have categorized as the procedure of charitable market the consultant to control who contracts and endowments loan as well as at what amount. Complete liberalization includes government similarly permitting entrance into monetary-service business to somewhat corporation that can placate accurately stated standards based on practical thoughts (regarding capital, services, and repute), give banks sovereignty to operate their peculiar activities, diminishing from possession of financial sector, and deserting governor over worldwide capital arrangements. Above mention description recommends six extents about financial liberalization:

1.      The removal of credit ceiling 

2.      Deregulation of rate of interest

3.      Allowed entry into financial sector

4.      Financial autonomy

5.      Private possession of banks

6.      Liberalization of worldwide capital movements

 They used word “Financial autonomy” that mean private internal domination actions of banks used to regulate substances such as how supervisors and employees have hired & what they remunerated, where twigs may be started or locked, and what kind of business bank involve. They argued that in financial repression the return on investment was not per nominal rate they consider the real rate that lead to negative values of financial investments. So, low interest rates discourage the investment level.

Mainly McKinnon theory focused on hypothesis about possessions of financial repression on economic development. McKinnon & Shaw claimed factually, many nations, with developed but specially emerging ones have constrained rivalry in banking sector with administration involvements and rules.
Implementation:

Year	Author	Methodology	Results
1975	Shigeyuki Abe, Maxwell J. Fry, Byoung K. Min, Pairoj Vongvipanond and Teh-Pei Yu	This article reviews a previous research done by Akhtar (1974) and a critical analysis of his approach and use of McKinnon’s theory was done.	The results found out were rather similar to those obtained by Akhtar (1974) but it was found out that using expected inflation rate proved to be highly significant.
1978	Maxwell J. Fry	Pooled time series analysis of ten Asian LDCs was done using their annual observations in order to test economic development with the help of models developed by McKinnon and Shaw.	Savings and economic growth were both affected by financial conditions of seven out of ten countries.
1990	Prem S. Laumas	The focus of this article is on an underdeveloped and financially limited economy, in this case India. Data chosen for this study was of one financial year of 1968-1969.	The results mentioned that even though there existed complementarity between physical capital and money in India, it should not be concluded that implementing financial liberalization would always end up in increased capital accumulation.
1992	Adedoyin Soyibo & Femi Adekanye	The effect of implementing and deregulating financial liberalization in Nigeria was tested. Data from years ranging between 1969 and 1989 was taken for analysis and determinants of savings in Nigeria were used as variables to test McKinnon’s and Shaw’s theory independently.	The results obtained showed that financial liberalization was slightly supported by Nigeria. Further results showed that Shaw’s debt-intermediation theory was supported more in case of Nigeria as compared to McKinnon’s complementary hypothesis.
1993	Professor Premachandra Athukorala & Dr. Sarath Rajapatirana	Empirical analysis carried out using OLS to explore the Sri Lankan financial market’s condition after its reforms in 1977.	McKinnon’s theory was supported as domestic savings increased with the increase interest rate, which further led to higher investments and the Sri Lankan financial market developed significantly.
1995	Syed M. Ahmed & Muhammed I. Ansari	OLS technique used to form linear equations of saving and money demand functions.	Even though some findings do support McKinnon-Shaw theory, rest of the factors prevailing in Bangladesh showed that interest rate based liberalization does not work in this case.
2002	Alan Dwyfor Evans, Christopher J. Green & Victor Murinde	Human capital and financial progress were assessed to measure growth of 82 countries since 21 years by using OLS and GLS techniques. McKinnon and Shaw’s model was used for the financial development.	It was found out that McKinnon’s complementary theory was supported by the results obtained, highlighting the complementarities between capital growth and financial market.
2002	Nicholas Odhiambo	This study is focused on the financial liberalization of Kenya where McKinnon’s theory was tested in both contexts of saving as well as money demand. Error correcting model based on co integration was used for testing.	The results showed that McKinnon’s theory was highly supported in Kenya and that previous researches regarding McKinnon’s theory provided weaker results due to limitations.
2005	Hafeez Ur Rehman & Abid Rashid Gill	The focus of this study is on Pakistan to test the McKinnon’s complementary theory. Model used for testing is VECM and data ranging from 1964 to 2003 is chosen.	The results of this study did not show a clear acceptance of McKinnon’s complementary theory existing in Pakistan; however they did match with a previous research done by Fry (1978) which talked about partial support of McKinnon’s theory.
2006	Eric J. Pentecost and Tomoe Moore	This study is focused on testing McKinnon’s complementary hypothesis in India, which is done by using multivariate co integration. The data used for this study ranges from 1952 to 2000.	The results showed that McKinnon’s complementary hypothesis is highly supported in case of India and it further strengthens previous researches proving that complementarity exists between money and capital in India.
2009	Tomoe Moore	Data of 108 developing countries ranging between 1970 and 2006 is chosen for conducting empirical research to support the McKinnon’s complementary hypothesis.	Results obtained supported the hypothesis of McKinnon, but it was also found out that the impact of external factors such as financial development, public discounts, different income levels or external inflows, the theory becomes less significant.
2010	Santigie M. Kargbo	ARDL approach used for annual data of years ranging from 1977 to 2008 specifically for Sierra Leone in order to test McKinnon’s complementary hypothesis.	Partial support for McKinnon’s theory existed in Sierra Leone and it was further found out that there existed a need for positive real interest rates in order to attain economic growth.
2012	Fidelos O. Ogwumike & Donald Ikenna Ofoegbo	Use of ARDL estimation method based on McKinnon’s complementary theory was done, and data taken was from 1970-2009 of Nigeria’s domestic savings to explore the effect of financial liberalization.	Unable to achieve positive real interest rate, leading to fewer savings. It was found out that interest rates were unable to make promote deposit or savings through liberalization, hence McKinnon’s theory failed in Nigeria.
2012	Amaira Bouzid	Co integration regression and VECM were used to devise money demand and investment functions. Yearly time series data for Arab countries, Morocco, Tunisia and Algeria was taken from 1973 to 2003.	Financial systems were underdeveloped in Tunisia and Morocco, which led to McKinnon-Shaw hypothesis being ensured only in case of Algeria.

Criticism

• Dr Firdu (2003) said that if the financial liberalization applied for the capital flow it does mislead the financial market. Suppose if the capital account liberalized then capital inflow will be mostly in those sectors that are import based and that sectors will be in protector mode but on the other hand may be amount collected through these sectors are not favorable for the country and proved as disadvantages for the country.
• According to Demirguc (1998) Financial liberalization is not possible if the corporate sectors governing authority poor and has less protection of legal law in this case the information and transactions provided will be asymmetries for the market (financial)because of this situation it cannot be possible to think about financial liberalization either international or domestic. In contrast where has the capacity to honor the work there can be possibility of no presumption about the above situation,
• Van Wijnbergen (1983) he argue in the favor of financial repression rather than financial liberalization he said  financial repression has many benefits for example on the bases of lower rate improve the loans performance, on the lower capital price enhance the equity, rate of growth accelerate if the loan is targeted in the direction of exporter and highly technological.
• Stiglitz (1994) argued that financial liberalization is not apt for the domestic market as capital account allows the flow of capital from the developed countries to developing countries it shows fragmentation in domestic market and also decrease the liquidity of the firm so it’s prohibited somewhere.
• Diaz-Alejandro (1985) argued that financial liberalization leads to instability at macroeconomics level. For the aimed to cut the financial repression financial reform carried out but often become the reason of financial crisis because of bankruptcies, intervention of the government, domestic saving at low rate and transform the private institute into nationalize. However probability of the crisis decreased with the level of development in different institution. Particularly Stiglitz said government is the insurer of the financial system and have significant repercussions (fiscal).
• Tome Moore (2009) argued that this theory is not suitable for middle income group of countries it’s just applicable for the less develop countries
• According to Neoclassical approach (1990) state increase in real rate of return doesn’t increase the proportion of saving because of external finance every firm has approached to it. It increased real cash holding balance.
• Fry (1978) criticize that in this theory monetary as well as non-monetary assets both should be included.
• According to Neoclassical approach (1990) price of capital is important for private investment but McKinnon said availability of self-finance is important for private investment.

·         Abayomi and Likhide (1997) said that in many countries financial liberalization has not been proved beneficial because of this interest rate and bankruptcies sharply increased and the condition of inflation become worsened.

• Van Wijnbergen (1983) proposed that Mckinnon had not focused on informal real credit market where the poor borrower and lender involve for lending and borrowing purpose.
• Tylor (1983) said that Stagflation (period of slow economic growth) just because of financial liberalization.
• Balassa (1989) who showed the objection on Mickinnon’s theory and argued that curb markets (where shares deals) are crucial for financial liberalization which gave the small benefit because of inefficient investment.
• Burkett and Dutt (1999) argued that financial liberalization reduced the aggregate demand and when aggregate demand reduced the total profit on investment also reduced.
  

Bibliography

Abe, S., Fry, M. J., Min, B. K., Vongvipanond, P., & Yu, T.-P. (1975).The demand for money in Pakistan: Some alternative estimates. The Pakistan Development Review, 14(2), 249-257.

Ahmed, S. M., & Ansari, M. I. (1995). Financial Development in Bangladesh—A Test of the McKinnon-Shaw Model. Canadian Journal of Development Studies/Revue canadienne d'études du développement, 16(2), 291-302.

Athukorala, P. P., & Rajapatirana, D. S. (1993). Liberalization of the domestic financial market: Theoretical issues with evidence from Sri Lanka. International Economic Journal, 7(4), 17-33.

Bouzid, A. (2012). McKinnon’s Complementarity Hypothesis: Empirical Evidence for the Arab Maghrebean Countries. The Romanian Economic Journal, 44, 23-36.

Evans, A. D., Green, C. J., & Murinde, V. (2002). Human capital and financial development in economic growth: New evidence using the translog production function. International Journal of Finance & Economics, 7(2), 123-140.

Fry, M. J. (1978). Money and Capital or Financial Deepening in Economic Development? Journal of money, credit and banking, 464-475.

Gill, H. U. (2005). A Test of McKinnon's Complementarity Hypothesis: A Case Study of  Pakistan. Pakistan Economic and Social Review, 43, 21-37.

Kargbo, S. M. (2010). Financial Liberalization and Savings Mobilization in Sierra Leone: A Test of McKinnon’s Complementarity Hypothesis. West African Journal of Monetary and Economic Integration, 10(1), 131-170.

Laumas, P. S. (1990). Monetization, Financial Liberalization, and Economic Development. Economic Development and Cultural Change, 38(2), 377-390.

Moore, T. (2010). A critical appraisal of McKinnon’s complementarity hypothesis: Does the real rate of return on money matter for investment in developing countries? World Development, 38(3), 260-269.

Odhiambo, N. (2002). Financial Sector Reforms, Savings, and Economic Development in Kenya. African Review of Money Finance and Banking, 5-22.

Ogwumike, F. O., & Ofoegbu, D. I. (2012). Financial Liberalization and Domestic Savings in Nigeria. The Social Sciences, 7(4), 635-646.

Pentecost, E. J., & Moore, T. (2006). Financial liberalization in India and a new test of the complementarity hypothesis. Economic development and cultural change, 54(2), 487-502.

Soyibo, A., & Adekanye, F. (1992). Financial systems regulation, deregulation and savings mobilization in Nigeria.