Trade–Finance Nexus: The Centrality of the Quality of Institutions in Sub-Saharan African Leading Economies

Published date01 February 2024
AuthorFisayo Fagbemi,Adeyemi Fajingbesi,Geraldine Ejiaka Nzeribe
Date01 February 2024
Subject MatterArticles
Trade–Finance Nexus:
The Centrality of the
Quality of Institutions
in Sub-Saharan African
Leading Economies
Fisayo Fagbemi1, Adeyemi Fajingbesi2 and
Geraldine Ejiaka Nzeribe3
The study examines the interaction effect of trade and institutional quality on finan-
cial sector development in 20 leading economies in sub-Saharan Africa selected
based on 2018 GDP per capita ranking (top 20 richest economies by GDP per
capita released by the IMF) over the period 2005–2020. Using system-generalised
method of moments estimation, the results indicate that the effect of the interac-
tion term of trade and regulatory quality on financial development is positive and
significant. Further findings show unidirectional causality running from the interac-
tion term to financial development, implying that the likelihood of trade enhancing
financial development depends on the soundness of the regulatory framework.
It is confirmed that the magnitude and direction of the effect of trade on finan-
cial development are sensitive to the quality of institutions. Therefore, the poor
quality of regulations on business activities and financial services could undermine
the salutary impact of trade on financial development. It is suggested that creating
a conducive regulatory environment to improve the level of financial development
is crucial for mitigating the potential impact of the weak institutional quality risks.
This remains a significant prerequisite for having a competitive business environ-
ment, thereby stimulating the role of trade in the process of financial development.
Financial sector development, trade, institutional quality, generalised method of
moments, sub-Saharan Africa
Foreign Trade Review
59(1) 7–25, 2024
© 2023 Indian Institute of
Foreign Trade
Article reuse guidelines:
DOI: 10.1177/00157325221137173
1 Obafemi Awolowo University, Ile–Ife, Nigeria
2 Research and Training, National Institute for Legislative and Democratic Studies, National Assembly,
Abuja, Nigeria
3 Nnamdi Azikiwe University, Awka, Nigeria
Corresponding author:
Fisayo Fagbemi, Department of Economics, Obafemi Awolowo University, Ile–Ife, Nigeria.
8 Foreign Trade Review 59(1)
The political and socio-economic globalisation has been driven by the movement
of human resources, goods and services (such as financial services) across national
borders. Based on classical theories (such as absolute advantage), comparative
advantage and Heckscher–Ohlin’s factor endowments, countries get involved in
trade basically due to relative costs of production or factor endowments over
others. Thus, opening up the economy to trade is central to improved economic
performance. Although with significant knock-on benefits for the economy as a
whole, openness to foreign financial services can lead to greater efficiency, dyna-
mism and innovation by the providers, thereby stimulating the development of the
domestic financial sector (Claessens, 2006; Mattoo et al., 2001).
In recognition of the significance of continental trade, African countries, on
30 May 2019, entered into force of the African Continental Free Trade Agreement
(AfCFTA), which offers a significant avenue for the continued increase in their
trade with respect to services. Accordingly, it is essential to give attention to the
prominent role of services as the AfCFTA negotiations persist, because services
seem to play a critical role in intra-African integration and the future of continen-
tal trade (Madden, 2019). It has become imperative for Africa to embrace this ini-
tiative, as Trade Facilitation Agreement may result in a decrease in trade costs of
up to 15%, and has been linked to the attainment of the 2030 Agenda for Sustainable
Development (UNCTAD, 2018). Hence, deep analysis of trade–finance nexus
is crucial to economic development, especially in the African context. Given that
economic prosperity is often measured by GDP per capita growth rates, the study
focuses on 20 leading economies in sub-Saharan Africa (SSA). These countries are
selected based on GDP per capita ranking (top 20 richest economies by GDP per
capita (PPP) released by IMF (IMF, World Economic Outlook, 2018)). Pertaining
to SSA in general, given the size of their GDP per capita, most of the selected coun-
tries contribute significantly to the region’s economic performance. For instance,
Nigeria, which is among the countries selected, accounts for over 70% of sub-
regional GDP in West Africa, and if Ghana, Côte d’Ivoire and Senegal are added,
in total, it will amount to 90% (African Development Bank (AFDB), West African
Economic Outlook, 2018). As a result, the study’s findings can be sufficient for
offering effective policy measures considered appropriate for entire SSA countries.
Financial sector development has been the key stimulator of economic growth
(Assefa & Mollick, 2017; Levine et al.,2000). While it has been discovered that SSA
financial sectors are mainly bank-based, the region’s financial systems are largely
underdeveloped (Andrianaivo & Yartey, 2009). A survey of the financial sector
reforms between the 1980s and 1990s regarding Africa revealed that the move to
improve the financial sector resulted in the enactment of some critical reforms, such
as the liberalisation of interest rates, abrogation of credit ceilings, restructuring and
privatisation of state-owned banks, institutionalisation of a variety of measures to
enhance the development of financial markets (Senbet & Otchere, 2006). Nonetheless,
Rajan and Zingales (2003) and Ibrahim and Alagidede (2017) opine that legal origin
hugely elucidates the cross-country differences in the development of the financial
sector. The argument, therefore, that financial sector development could be strongly

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