Therefore, it is very crucial toimplement deeper studies of the role of human capital in different economies, so that many policymakers in Asian countries may become more cautious about
INTRODUCTION
Research Motivation
Asia is a diverse continent with varying levels of development among its nations While countries like Japan, Korea, and Singapore have made significant economic strides, others continue to face developmental challenges Historical events, such as the Asian economic crisis of the late 1990s, still impact nations like Indonesia, Malaysia, Thailand, and South Korea Currently, Asian economies are grappling with obstacles such as rising interest rates from the U.S Federal Reserve, a decline in China's economy, and disruptions in the global supply chain, compounded by volatile prices of food, commodities, and energy due to external factors like the Russia-Ukraine war The financial strain from the COVID-19 pandemic has led to low expenditure levels, and despite some countries lowering interest rates, they struggle with capital absorption, hindering immediate developmental progress Consequently, economic recovery in Asia is stalling amidst tight conditions and a weakened global environment Additionally, the region faces significant challenges in infrastructure, education, healthcare, and investment opportunities Therefore, fostering economic growth in Asian countries is vital for alleviating poverty, establishing stable financial systems, promoting cooperation, and benefiting individuals and the broader region.
Neoclassical economic theory, as highlighted by Harrod, Solow, and Domar, provides a valuable framework for understanding the financial sector's crucial role in economic growth Investment is identified as the primary driver of economic expansion, with the growth rate directly linked to capital growth The theory posits that capital change equals new investment minus depreciation, establishing that the investment rate should match the saving rate By integrating these concepts, economic growth can be quantified as the average product of capital, adjusted for depreciation and influenced by the saving rate Consequently, financial development is vital for economic expansion, as it connects savings with investments In the absence of financial intermediaries, individuals with low incomes may resort to high-interest lenders for loans Overall, the financial industry is essential in facilitating investment, which serves as a catalyst for economic growth.
Numerous studies highlight the mutually beneficial relationship between financial development and economic growth, with Patrick (1966) identifying three key ways the financial industry influences growth: by enhancing capital allocation efficiency, serving as an intermediary between corporations and savers, and incentivizing increased savings Levine (1997) emphasizes that effective financial institutions are crucial for national economic growth, as they reduce risks, lower transaction costs, and facilitate trade and access to financial services However, researchers like Handa and Khan (2018) argue that financial systems in low- and middle-income countries are underdeveloped, limiting the positive effects of financial development on growth Cheng et al (2021) further indicate that financial development can negatively impact economic growth in 72 nations, particularly in high-income countries, where weak financial institutions may lead to resource wastage and speculative behavior Additionally, the relationship between financial development and economic growth may also manifest in a nonlinear form, as discussed in various studies, including those by Aghion et al (2005) and Asongu (2011).
While the link between financial development and economic growth is well-established, most research has focused on developed countries like the United States and Europe, leaving a notable gap in our understanding of this relationship in developing regions such as Asia Consequently, the authors have identified that the connection between financial development and economic growth remains unclear and unresolved This uncertainty serves as a key motivation for the authors to provide empirical evidence on the financial development-economic growth correlation specifically within the Asian context.
The New Growth Theory recognizes human capital as a crucial determinant of economic growth between the 1980s and the 1990s, with the pioneering works by Romer
Human capital significantly influences economic growth in two primary ways: by enhancing productivity through skilled labor and by stimulating technological innovation within businesses According to the endogenous growth model by Aghion and Howitt, human capital not only drives economic growth but also creates more opportunities for investment in itself Despite its undeniable importance, the impact of human capital varies across countries due to institutional factors, demographic characteristics, and labor force differences Therefore, it is essential to conduct in-depth studies on the role of human capital in various economies This understanding will help policymakers in Asian countries approach financial sector liberalization cautiously, as excessive liberalization may hinder the correlation between financial development and economic growth in the region, necessitating tailored strategies for the current Asian context.
This study aims to empirically investigate the correlation between finance and economic growth in Asia, highlighting the significance of introducing Human Capital and Institutional Quality as moderating variables By addressing the limited research on these factors, the findings will contribute to a deeper understanding of their roles in promoting regional economic development.
Research Objectives
Numerous studies have produced varying results regarding the relationship between financial development and economic growth, indicating positive, negative, or no correlation Acknowledging the ambiguity of this relationship, this research paper aims to investigate the effects of financial development on economic growth Furthermore, the authors will examine how Human Capital and Institutional Quality influence the connection between these two critical factors.
To draw more precise conclusions, the authors will expand the research scope by introducing two moderating variables—Human Capital and Institutional Quality—and employing the Two-step system GMM model They will subsequently recommend effective strategies for the nation to address its economic and social challenges.
Correlated with these problems presented, the authors will solve the following questions:
1 Does Financial Development have a significant impact on Economic Growth?
2 Do Human Capital and Institutional Quality moderate the relationship between Financial Development and Economic Growth?
Research Methodology
This study employs a quantitative analysis of unbalanced panel data using STATA version 14 and various econometric methods Initially, the authors applied pooled Ordinary Least Squares (OLS), fixed effects model (FEM), random effects model (REM), and Generalized Least Squares (GLS), followed by a Hausman specification test to identify the most appropriate model Subsequently, the Two-step System Generalized Method of Moments (GMM) approach was utilized to address endogeneity and autocorrelation issues.
Object and Scope of Research
Between 2013 and 2022, researchers conducted a comprehensive study involving data from 46 Asian nations to explore the connection between financial development and economic growth The analysis also considered institutional quality and human capital as key moderating factors, highlighting their significant contributions to the overall model.
Research Novelty
Asia, the most populous continent with over 4.64 billion people, showcases a diverse range of nations at different development stages, influenced by factors like institutional quality and natural resources While countries like Japan, South Korea, and Singapore have made significant social and economic progress, many others face persistent growth challenges The ongoing rise in interest rates by the US Federal Reserve has compounded these issues, leading to slower growth in major economies like China and disruptions in the global supply chain Additionally, the Russia-Ukraine war has caused price volatility in food and energy, while the lingering effects of the COVID-19 pandemic have resulted in low consumption and expenditure levels across the region Despite attempts to lower interest rates to alleviate financial pressure, generating substantial growth momentum remains difficult due to challenges in capital absorption Consequently, tightening financial conditions and a deteriorating global environment are contributing to the slowdown of economic growth in Asia.
The authors identified a significant limitation in previous studies, noting that most were conducted between 1963 and 1999 and lacked representation from Asia To address this gap, they extended the research period to 2013-2022, a time of considerable global change, and included 46 Asian countries This approach aims to provide a more comprehensive understanding of the pressing issues currently facing Asia.
Numerous studies have explored the link between financial development and economic growth, but this article highlights the significant roles of human capital and institutional quality, particularly in Asia With exceptional human capital characterized by high IQ levels and educational quality recognized by the PISA Survey, these factors are crucial for driving economic growth The authors argue that incorporating human capital and institutional quality as moderating variables can enhance the accuracy and applicability of economic models.
Previous research primarily employed Pooled OLS or GLS models, which often retained endogenous factors, resulting in inaccurate final outcomes To enhance accuracy, the authors opted to implement a Two-Step System GMM model, effectively addressing these issues Furthermore, incorporating robustness assessments will contribute to the model's stability by evaluating specific variables.
Research Contribution
This study contributes theoretical and practical significance.
This research aims to explore the relationship between financial development and economic growth across various Asian countries at different stages of progress It offers a comprehensive overview of the topic, supported by relevant theoretical frameworks, particularly the New Growth Theory Utilizing a Two-Step system GMM approach, this study analyzes panel data from 46 Asian countries, addressing existing research gaps Additionally, the authors identify institutional quality and human capital as significant moderating variables influencing economic growth in Asia, highlighting the lack of discussion on these factors together in existing literature, which predominantly focuses on America and Europe This study aspires to pave the way for future research in the Asian context.
This empirical study reveals a significant positive correlation between financial development and economic growth, with human capital and institutional quality acting as key enhancers of this relationship The findings will guide policymakers in Asian countries to prioritize investments in human capital and institutional quality To achieve sustainable development goals, governments should concentrate on improving investment opportunities, streamlining financial systems, fostering economic cooperation, and developing robust educational and healthcare infrastructures Additionally, reinforcing national laws and enhancing management efficiency are crucial steps for future progress.
Research Structure
The research is structured into five chapters, beginning with Chapter 1, which outlines the study's subject, objectives, methodology, and contributions Chapter 2 offers a critical evaluation of relevant findings and theoretical frameworks In Chapter 3, the research model, data, and economic methodologies are explored in detail Chapter 4 presents a discussion of the empirical results, while Chapter 5 concludes the work with insights on research conclusions, recommendations, limitations, and future research directions.
This chapter presents the research topic by outlining its motivation, objectives, methodology, and scope, while also highlighting its novelty and contributions These elements offer readers a thorough understanding of the research Additionally, Chapter 1 lays the foundational concepts of the topic, thereby supporting future research endeavors.
LITERATURE REVIEW
Concept definition
Financial development encompasses the progress in sharing knowledge about investment opportunities and capital allocation, enhancing corporate governance and business oversight, improving trading and risk management strategies, mobilizing and pooling savings, and facilitating the exchange of goods and services.
Financial development, as defined by Okoye and Ezema (2021), involves enhancing funding mechanisms, refining financial institution operations, innovating financial products, and improving the effectiveness of financial intermediary services Slesman et al (2019) further characterize financial development as a multidimensional concept, emphasizing the importance of the financial sector's efficiency and efficacy in facilitating intermediation between surplus and deficit units within the economy.
Financial development involves enhancing a country's financial systems to offer diverse services to individuals, businesses, and governments According to the World Economic Forum (2012), this process relies on various factors, regulations, and institutions that ensure effective financial intermediation and capital availability Slesman et al (2019) highlight that financial development supports numerous markets, infrastructure, and organizations, enabling efficient capital flow This expansion of financial services benefits the overall economy (Imoagwu & Ezeanyeji, 2019) A strong financial system is crucial for identifying opportunities, mobilizing funds, facilitating trade, managing risks, and stimulating economic activity, all of which drive economic growth (Sanusi, 2011).
Countries with advanced financial systems tend to experience faster long-term economic growth, and increasing evidence indicates a direct correlation between financial development and economic growth, rather than the latter merely being a byproduct of the former.
According to Mladen (2015), economic growth is commonly understood as the annual increase in a country's production output over a defined period, typically measured in terms of gross domestic product (GDP) or national income.
In recent years, economists have conducted extensive studies on economic growth, highlighting its significance as a key indicator of a country's wealth and overall economic health This focus has drawn considerable attention from researchers, leading to various empirical investigations aimed at understanding the implications of economic growth and its effects on different aspects of a nation.
Economic growth, as defined by Cornwall (2024), is the process through which a country's wealth increases over time, typically reflecting long-term gains rather than short-term economic success Kuznets (1973) further elaborates that this growth represents a sustained rise in a nation's ability to provide a diverse array of economic goods to its citizens, driven by technological advancements and the necessary institutional and ideological changes.
Economic growth is defined as the increase in a country's wealth over time, with the real rate of growth in total production of goods and services being the primary measure (Britannica, 2003) Several factors influence this growth rate, including natural resources, human capital, capital resources, technological advancements, and the stability of institutional structures Additionally, economic growth signifies a continuous enhancement of living standards within a nation, region, or city, alongside ongoing transformations in the economy's industrial base (Ray, 1998).
According to Smith (2015), a key focus of economic theory is enhancing societal welfare and economic growth, which reflects the wealth dynamics of nations and their citizens Modern economic growth theory has evolved through various factors, including labor division, education, human capital, technological advancements, and the influence of institutional frameworks such as competitive markets and government roles Nelson (2023) adds that economic growth represents a consistent increase in a nation's capacity to produce goods and services, leading to higher per capita income, fueled by technological progress, institutional reforms, and ideological transformations.
Economic growth is crucial for improving living standards, as it helps lift people out of poverty and enhances the quality of their lives, ultimately achieving society's fundamental goal Research by Subruto (2015) highlights the significance of economic growth in poverty reduction, emphasizing the need for sustained growth to ensure long-term poverty alleviation.
(2016), economic growth mainly depends on having more resources or the policy of macroeconomics, technological advancements, and good governance.
Economic growth is influenced not only by key inputs like land, labor, capital, and technology but also by the social, economic, and political frameworks within a nation It is interconnected with various sectors, particularly financial development, human capital, and the quality of institutions Consequently, economic growth is often a primary goal associated with the overall development and value enhancement of a nation.
The World Bank defines human capital as the collective health, knowledge, and skills individuals acquire throughout their lives, essential for achieving their full potential in society To eradicate severe poverty and foster inclusive communities, it is crucial to accumulate human capital Key contributions to this accumulation include access to quality education, healthcare, nutrition, and job skills development.
Human capital encompasses not only the intrinsic skills and traits of individuals but also their motivations and behaviors, contributing to economic output and the enhancement of social and personal well-being, including physical, emotional, and mental health (UNECE, 2016) Nelson and Phelps (1966) assert that human capital acts as a catalyst for increased productivity through innovation, facilitating the adaptation to new manufacturing techniques Their research indicates that a greater endowment of human capital correlates with elevated levels of innovation.
Investing in human capital can take various forms, as highlighted by Abraham and Mackie (2005) Early childhood interactions by parents significantly contribute to the cognitive, emotional, and social development of children, representing a crucial investment Additionally, formal education, ranging from basic schooling to college and postgraduate programs, plays a vital role in enhancing individuals' capacities After formal education, people often engage in organized training or informal job-based learning While all forms of investment in human capital are important, formal education has garnered the most attention, particularly in measuring the human capital acquired through these educational pursuits.
Numerous studies highlight the critical role of human capital in economic performance, with Barro (1991) identifying it as a key predictor of per capita income Aghion and Howitt (1998) further underscore its importance in fostering technological investment, which positively impacts economic growth According to the World Development Report (2019), the rapidly evolving skill frontier presents both opportunities and challenges Increasing evidence suggests that without enhancing human capital, nations risk missing out on sustainable and inclusive economic growth, failing to develop a workforce ready for future skilled jobs, and struggling to compete in the global market Consequently, the costs associated with neglecting human capital development are escalating.
Theoretical framework
The 1956 study "A Contribution to the Theory of Economic Growth" by Robert Solow laid the groundwork for modern economic growth theory Solow's neoclassical growth model highlights the importance of capital accumulation, labor force growth, and technological advancement in driving economic progress This foundational work continues to influence contemporary understanding of economic growth dynamics.
By the mid-20th century, the neoclassical growth model, established by Cass (1965) and others, became the dominant framework for understanding economic growth This model is built on a production function that assumes constant returns to scale and diminishing returns to labor and capital, while also allowing for easy substitution between inputs According to Kose et al (2010), financial globalization drives economic growth primarily through increased capital, which flows from capital-rich to capital-poor economies This influx of capital is expected to enhance domestic savings in low-capital nations and promote investment by reducing the cost of capital.
In 1992, Mankiw, Romer, and Weil enhanced Solow's neoclassical growth model, leading to significant advancements in economic theory Building on this foundation, Atje and Jovanovic (1993) integrated the stock market into the Mankiw-Romer-Weil (MRW) growth model Their analysis of cross-national data suggests that the development of the stock market may serve as an important precursor to economic growth.
In 2010, the MRW growth model was enhanced by distinguishing between stock market capital and non-stock market capital, following the framework established by Atje and Jovanovic (1993) Both models align with our theoretical and empirical findings, suggesting that the stock market is a significant factor affecting the steady-state level of per capita growth.
Drawing from the aforementioned theory, the study conducted by the authors aims to bolster the significance of financial development in the context of economic growth of 46 countries in Asia.
The supply-leading theory suggests that financial innovation plays a significant role in driving a country's economic growth This concept, rooted in the work of Schumpeter, emphasizes the connection between financial development and economic expansion.
Financial innovation plays a crucial role in accelerating wealth creation and enhancing the efficiency of financial enterprises, as highlighted by Gurley and Shaw (1955), Goldsmith (1969), and Mckinnon and Shaw (1973) This theory posits that a robust financial system fosters economic growth by expanding the supply of financial services through the development of financial markets and institutions The McKinnon-Shaw School argues that low real interest rates discourage saving, resulting in a reduced availability of loanable funds for investment, which ultimately hampers economic growth.
The McKinnon-Shaw model suggests that financial liberalization enhances interest rates and competition, leading to increased savings and investment, which ultimately supports economic growth (AbuBader & Abu-Qarn, 2008; Ang, 2008; Calderon & Liu, 2003; Khan & Senhadji, 2000) This study posits that a robust and efficient financial system is crucial for providing the necessary funds to sustain various economic components and initiatives, thereby reinforcing economic growth in Asia.
The effectiveness of financial development in enhancing economic growth is significantly influenced by the quality of a country's institutions Without corresponding institutional improvements, advancements in finance may lead to slower increases in economic complexity This study aligns with the law and finance theory proposed by La Porta et al (1998), which emphasizes that a robust legal framework and high-quality institutions foster fairness and security in the financial system Such institutional frameworks create a supportive environment for savings and investments, directing resources toward growth-oriented activities like R&D, innovation, and entrepreneurship Strong institutions also protect stakeholders' interests, mitigating risks associated with political interference, corruption, and opportunism This research aims to explore how institutional quality influences the relationship between financial development and economic complexity in Asia.
The concept of endogenous growth theory, introduced by Hirofumi Uzawa in 1965, explores the impact of public goods, health, education, and other factors on labor efficiency within the Harrod-neutral technology economic growth model Uzawa's model highlights the educational sector's role in influencing these components, although he did not explicitly mention human capital In contrast, Robert Lucas's 1988 research presented a model that directly incorporates human capital, further advancing the understanding of growth dynamics.
The emergence of endogenous growth theory, introduced by Lucas (1988) and Romer (1986), has shifted the focus of growth literature towards human capital in the twenty-first century This theory challenges traditional neo-classical growth models by asserting that, despite experiencing diminishing returns, a stable return to scale can be achieved through effective investment in human capital.
In 1986, a long-term economic growth model was introduced, highlighting the role of human education as a key production input that enhances marginal productivity and stimulates growth The model suggests that nations with a robust human capital foundation can experience significantly faster expansion compared to those with a limited human capital base.
Accordingly, the authors consider that it's important to look into how Human Capital, the moderating component, strengthens the relationship between Financial Development and Economic Growth.
Empirical evidence
2.3 Ỉ The relationship between Financial development and Economic growth
In today's economy, the financial industry's development is crucial for economic growth, as it fosters a symbiotic relationship where financial advancements enhance economic progress Financial development lowers transaction costs, encourages savings, promotes investment, and drives financial innovations, all of which contribute to sustained economic growth Recent studies on the impact of financial development on economic growth have produced mixed results, with some indicating positive effects, others showing negative outcomes, and some yielding inconclusive findings.
Numerous studies, in terms of the empirical literature, have concentrated on examining the correlation between financial development and economic growth.
Levine (1997) presents a theoretical framework highlighting the positive interaction between financial development and economic growth, a view further supported by Levin (2005), who asserts that economic growth is positively correlated with financial development He outlines key scenarios demonstrating that greater financial development leads to improved capital accumulation through more efficient mobilization of savings, ultimately driving higher economic growth Additionally, enhanced financial development facilitates not only the commercial trade of goods and services but also promotes specialization, which in turn boosts labor efficiency and production outputs.
Numerous studies have explored the relationship between economic growth and financial development, highlighting its significance King and Levine (1993) conducted empirical research across 77 nations from 1960 to 1989, revealing a positive interaction between economic growth and financial development through regression analysis of various financial indicators Similarly, Rajan and Zingales (1998) confirmed this beneficial relationship, a finding supported by Levine & Zervos (1998) and Beck & Levine (2002), who emphasized the crucial role of financial development in fostering economic growth Levine (2005) articulated that financial development enhances capital raising and resource allocation, stimulating economic progress Galindo et al (2007) further suggested that improved financial development leads to more efficient credit allocation by banks, accelerating economic growth Additionally, Ang and McKibbin (2007) and Giuliano and Ruiz-Arranz (2009) highlighted that financial development aids in better mobilization of household savings and efficient investment choices Pioneering economists like Goldsmith (1969), McKinnon (1973), and Shaw (1973) noted that financial development reduces market frictions, increases domestic savings, and attracts foreign capital, ultimately contributing to capital accumulation and lowering external financing costs for firms, which drives overall economic growth.
Economic growth, defined as the increase in an economy's capacity to produce goods and services over time, can be assessed in both nominal terms, which include inflation, and real terms, which are adjusted for inflation This growth is often measured using indicators like GDP and GDP per capita, allowing for comparisons of economic performance between countries while accounting for population differences.
Bencivenga and Smith (1991) emphasize that the evolution of banks can significantly enhance economic growth by directing savings towards high-productivity activities and helping individuals mitigate liquidity risk Consequently, financial development plays a crucial role in boosting the efficiency of economic growth Additionally, Levine and Zervos (1998) conducted a study involving 47 countries, further supporting these findings.
Between 1976 and 1993, research indicated that stock market liquidity and banking developments positively impacted economic growth, considering factors like fiscal policy, trade openness, education, and political stability Zheng and Yu (2009) found a positive correlation between financial development and economic growth in 29 provinces from 1994 to 2005, a conclusion supported by Wen (2009) in a study of six central provinces in China from 1978 to 2007 Additionally, Zhang et al (2012) identified a beneficial relationship between economic growth and financial development using data from 286 cities between 2001 and 2006 A study by Gregorio and Guidotti (1995) involving 98 nations from 1960 to 1985 confirmed that financial development fosters economic growth due to the financial system's capacity for profitable investments Akinov et al (2009) also reported a significant positive interaction between financial development and economic growth in 27 transition economies from 1989 to 2004 Overall, these studies highlight the crucial link between financial development and economic growth, particularly following China's accession to the World Trade Organization (WTO).
In 2001, the rise of foreign banks led domestic banks to improve their efficiency to remain competitive This shift resulted in a more effective banking structure that fosters profitable investments, ultimately driving economic growth.
Research indicates a complex relationship between financial development and economic growth, where increased financial activity can enhance capital allocation, reduce transaction costs, and promote lending to businesses and households, ultimately fostering profitable investments While many studies suggest a positive correlation between financial development and economic growth in certain countries, others highlight that this relationship can be negative or negligible in specific contexts Thus, financial development may significantly impact economic growth in some areas, while having little to no effect in others.
Several studies have explored the relationship between financial development and economic growth, revealing a generally negative correlation Yan et al (2015) utilized the Ordinary Least Square (OLS) model to analyze data from 1978 to 2013 in China, finding that financial development negatively impacts economic growth Similarly, Hasan et al (2009) reported a negative interaction between financial development and economic growth in a study of 31 provinces from 1986 to 2002 Fang and Jiang (2014) further corroborated this finding, examining annual data from 34 provinces between 1998 and 2010 and concluding that the finance-growth correlation remains negative across various industries Rong Sun (2023) also demonstrated a negative relationship in Shanxi Province by constructing a VAR model using data from 2000 to 2019 Additionally, Handa and Khan (2018) highlighted that less developed financial systems in low- and middle-income countries fail to yield positive effects on economic growth compared to high-income countries.
The financial crisis of 2007/2008 highlighted that even advanced financial systems can negatively impact economic growth According to Law and Singh (2014), a financial system breakdown can lead to resource wastage, decreased savings, and increased speculation, causing resource misallocation and underinvestment, which in turn can elevate unemployment and poverty rates Their research, covering 87 countries from 1980 to 2010, found a negative relationship between financial development and economic growth when the credit-to-private-sector ratio exceeds 88% or the illiquidity liability of GDP surpasses 91% Similarly, Hasan et al (2009) identified a negative correlation at the provincial level in China from 1986 to 2002, attributing it to the dominance of state-owned banks with high non-performing loans due to imprudent lending practices Adusei (2013) supports this view, stating that inadequate government oversight in Ghana has led to excessive lending and poor banking practices, further exacerbating the adverse correlation between finance and growth.
Ram (1999) conducted a study involving 95 countries, revealing a negative correlation between financial development (FIN) and economic growth (EG) using a basic multiple-regression growth model Similarly, Bloch and Tang (2003) analyzed data from 75 countries between 1960 and 1990, concluding that financial development is likely to be negatively related to economic growth Their findings suggest that the weak association between financial development and economic growth remains consistent despite changes in the indicators of financial development.
Research by De Gregorio and Guidotti (1998) on 77 Latin American countries revealed a negative relationship between financial development and economic growth Similarly, Rioja and Valev (2003) found that in 74 countries from 1961 to 1995, low levels of financial development negatively impacted economic growth Ang (2007) examined the channels through which financial development affects economic growth in Malaysia, confirming that financial development can enhance economic growth by improving investment performance, although some public investment programs may adversely affect it.
A study by Al-Kandari et al (2020) examined the relationship between financial development and economic growth in Kuwait using ordinary least squares regression and the Pairwise Granger Causality Test, revealing a significant negative correlation from 2001 to 2019 Similarly, Graff and Michael (2002) analyzed 93 countries from 1970 to 1990 and found that financial growth was negatively linked to economic growth during the 1975-1980 period Boyreau-Debray (2003) also reported a negative impact of financial development on local economic growth from 1990 to 1999, attributing this to the banking sector's support of unprofitable state-owned enterprises Furthermore, Hasan et al (2009) confirmed a negative influence of financial development on economic growth in their study of provincial data from 1986 to 2002.
Bank loans play a crucial role in promoting economic growth by facilitating business activities, as noted by Ho and Saadaoui (2022) An increase in bank loans can enhance loan utilization, which may lead to a negative feedback loop affecting growth if the financial system generates problematic debts, as discussed by Moyo et al (2018) and Nasir & Du (2018) Furthermore, financial crises arising from financial system disruptions can further hinder economic growth, creating a cyclical relationship that underscores the importance of a stable financial environment for sustainable economic development.
The simplistic narrative of "more finance, more growth" is challenged by Boteva et al (2019), who analyze a large sample of countries through a novel perspective Their research employs various measures of financial development to capture its multifaceted impacts on the real economy By utilizing innovative "threshold models," they uncover non-linear and uneven effects of financial development on economic growth, highlighting its influence during both stable and turbulent periods This study is pioneering in its development of a nonlinear dynamic specification to evaluate the effects of financial development across a diverse range of countries in varying economic climates.
Research gap
After reviewing previous studies, the authors identify significant limitations in research scale, particularly noting the outdated data series from various countries across different continents A notable example is the empirical study by King and Levine (1993), which analyzed 77 countries using data from 1960 to 1989.
Levine and Zervos (1998) conducted a study across 47 countries from 1976 to 1993, while De Gregorio and Guidotti (1998) explored the long-term relationship between financial development and economic growth in 77 Latin American countries Notably, these studies do not account for recent external factors, such as the COVID-19 pandemic and the Ukraine-Russia conflict, suggesting that their empirical findings may lack significant relevance in today's context.
To address existing challenges in economic development, the authors expanded their research to cover a recent period from 2013 to 2022, focusing on 46 Asian countries This region was chosen due to its advantages, such as a dense population, abundant resources, rich human capital, and diverse cultures, all of which create ideal conditions for economic growth However, despite these strengths, many Asian countries struggle to realize their full economic potential due to ongoing developmental obstacles.
The US Federal Reserve's interest rate hikes have adversely affected Asia's economy, resulting in a slowdown in China's growth and disruptions in the global supply chain, alongside signs of weak recovery Additionally, fluctuating food and energy prices due to the Russia-Ukraine conflict have compounded these challenges The financial strain on the Asian economy, exacerbated by the COVID-19 pandemic, has led to low consumption and spending levels Although interest rates have been cut to alleviate financial pressure, this has not fostered immediate strong growth momentum Overall, tighter financial conditions and a weakened global environment are significantly contributing to the slowdown of economic growth in Asia.
The correlation between financial development and economic growth has been extensively studied, yielding mixed results regarding its nature King and Levine (1993) found a positive relationship between financial development and economic growth across 77 countries from 1960 to 1989, while Levine (2005) supported this view, highlighting that enhanced financial development leads to increased capital accumulation and more efficient savings mobilization, ultimately fostering economic growth Conversely, some researchers, including Handa and Khan, challenge the existence of this positive interaction.
In 2018, a study evaluated 13 countries to assess the impact of financial development on economic growth, revealing that financial systems in low- and middle-income nations are less developed than those in high-income countries, leading to negative effects on growth However, the relationship between financial development and economic growth is also characterized by a non-linear form, as explored in previous research, including studies by Jawadi et al (2019), Asongu (2011), and And (2008).
The authors introduced two key factors, Human Capital and Institutional Quality, to enhance the understanding of the correlation between financial development and economic growth, particularly in Asian countries This focus on Asia is due to its rich cultural heritage and high educational standards, marked by equal gender enrollment across all education levels and nearly universal access to primary and secondary education The region has successfully reduced illiteracy and fostered strong proficiency in scientific and mathematical knowledge, with notable contributions from countries like China, Korea, and Singapore Recognized by PISA for its educational excellence, Asia leads globally in metrics such as IQ and population education By incorporating Human Capital and Institutional Quality as moderating variables, the authors aim to refine the model, allowing for a clearer and more precise examination of the financial development-economic growth relationship.
Many empirical studies have primarily utilized Ordinary Least Squares (OLS) and Generalized Least Squares (GLS) models to analyze the relationship between financial development and economic growth For example, Yan et al (2015) and Al Kandari et al (2020) employed OLS for data spanning various years, while Hussain et al (2024) utilized pooled OLS and fixed effect techniques In contrast, Rahaman et al (2023) and Islam (2022) applied the GLS model using panel data to explore the correlation between these two variables Although OLS and GLS models are favored for their simplicity and efficiency, they have limitations, including the potential presence of endogenous variables that can lead to inaccuracies To address these issues, the author opted for the Two-Step System GMM model, which offers improved accuracy and effectiveness, particularly with small samples, while also incorporating robustness checks for greater stability in the results.
Research hypothesis
The financial industry's growth is essential for overall economic expansion, as financial development and economic growth are interconnected Financial development typically follows economic growth, subsequently enhancing it By reducing transaction costs, leveraging financial innovations, promoting savings for investment, and increasing overall investment, financial development plays a pivotal role in supporting and accelerating economic growth.
Numerous studies have explored the relationship between financial development and economic growth, revealing significant connections across various nations King and Levine (1993) identified a strong link between these two factors in 77 countries from 1960 to 1989 Similarly, Levine and Zervos (1998) found that, after accounting for variables such as education and political stability, advancements in banking and stock market liquidity positively influenced economic growth in 47 nations between 1976 and 1993 Bencivenga and Smith (1991) emphasized that bank development enhances economic growth by directing savings to high-productivity sectors and reducing liquidity risk for individuals Furthermore, Zheng and Yu (2009) analyzed annual data from 29 provinces between 1994 and 2005, confirming a positive correlation between financial development and economic growth Overall, financial development is a crucial driver of economic effectiveness.
Research indicates a strong positive correlation between financial development and economic growth For instance, Zhang et al (2012) analyzed data from 286 cities between 2001 and 2006, confirming that a more efficient financial system fosters investment and, in turn, economic growth Similarly, Gregorio and Guidotti (1995) examined panel data from 98 countries from 1960 to 1985, highlighting the beneficial link between financial development and economic expansion Following China's accession to the World Trade Organization (WTO) in 2001, international banks began offering services in the country, prompting domestic banks to enhance their efficiency to remain competitive This improved banking system ultimately facilitates more effective investments, driving economic growth.
Numerous studies have highlighted a strong correlation between financial development and economic growth, leading to the hypothesis that financial development positively influences economic growth in certain countries This relationship is attributed to improved capital allocation, reduced adjustment costs, increased lending to individuals and businesses, and the promotion of high-return investments.
In line with this, the authors hypothesize that:
Hl: Financial Development has a positive impact on Economic Growth
Institutional quality significantly influences the financial growth of regions and countries According to Levine and Zervos (1998), factors such as openness, transparency, and robust institutions are crucial for fostering financial development Additionally, Law et al (2014) discovered that institutional connections are closely linked to the expansion of the financial sector, albeit in varying contexts Furthermore, Malarvizhi et al (2019) emphasized that the advancement of financial technology within the banking sector is heavily dependent on the quality of institutions.
Research indicates that institutions play a crucial and multifaceted role in economic complexity Siong and Muzafar (2009) highlight that institutions can create motivating structures that foster productive actions within society, establishing a framework for national economic activity Consequently, effective institutions can promote investment, growth, and development, while ineffective ones may impose barriers that lead to economic downturns (Butkiewicz and Yanikkaya, 2006) Efficient institutions are vital for economic progress as they influence investments in technology, humanities, and physical goods, while also coordinating production Although cultural and regional factors may also impact the economy, economic institutions are paramount as they determine a nation's growth potential and guide future resource allocation (Acemoglu et al., 2005).
Research indicates that institutional factors are vital for the efficient functioning of financial systems, which in turn influences resource allocation toward R&D, technology, and entrepreneurial activities The quality of these institutions significantly impacts the financial sector's ability to lower financing costs and effectively distribute resources to enhance technical and productive knowledge, essential for generating complex exports Well-functioning institutions help mitigate exploitation in financial markets by addressing issues like opportunism and rent-seeking behavior Consequently, without improvements in institutional quality, further growth of the financial sector may not lead to advancements in economic complexity.
In line with this, the authors hypothesize that:
H2: Institutional quality matters in promoting the relationship between financial development and economic growth.
Research by Bottazzi et al in 2004 indicates that scientific education significantly improves the quantity and quality of financial intermediation This enhancement of human capital reduces entry barriers and boosts participation in financial markets Additionally, increasing literacy rates can mitigate the growth losses associated with inadequate financial intermediation activities.
Nations with advanced human capital can leverage financial development more effectively, as they possess the necessary technology for thriving financial markets (Sharma, 2016) Research by Ibrahim and Sare (2018) on forty African countries highlights that trade openness and human capital serve as substitutes, significantly influencing the continent's financial growth.
Schultz (1961) conducts a quantitative assessment of education's impact on national product growth, calculating the education stock of the US population from 1900 to 1956 He measures the effectiveness of educational efforts through human capital training, equating human capital to capital equipment evaluated by the costs of education The analysis reveals that between 17% and 33% of US economic growth during this period can be attributed to increased education levels.
Ahsan and Haque (2017) conducted a study to analyze the threshold impact of human capital on economic growth in developed and underdeveloped countries Utilizing the Generalized Method of Moments (GMM) for their calculations, the findings reveal that human capital has a significant and positive effect on economic growth across both regions.
Research by Hanushek and Kimbo (2000) highlights the importance of quality education over quantity, using PISA and TIMSS test scores as indicators of human capital Additionally, Hanushek and Schultz (2012) found that a 100-point increase in PISA test scores could lead to a 2-percentage-point increase in GDP growth rate, underscoring the significant impact of educational quality on economic performance.
In accordance with these research, the authors hypothesize that:
H3: Human Capital is a contributing factor to the strengthening of the positive correlation relationship between Financial Development and Economic Growth.
This chapter presents the thorough overview of the financial development - economic growth relationship in theoretical and practical terms Following that, three research gaps are determined, including:
(1) The gap in the research scope, namely the out-dated time series and primarily focus on various continents;
(2) The gap in the clarity of the financial development and economic growth relationship whether it is positivc/ncgativc, or no correlation;
(3) The gap in data analysis of two models OLS and GLS, as there are still some endogenous variables after processing data.
This chapter discusses three research hypotheses concerning the finance-growth nexus, highlighting the influence of two moderating variables: Human Capital and Institutional Quality on this relationship.
Hl: Financial Development has a positive impact on Economic Growth.
H2: Institutional quality matters in promoting the relationship between financial development and economic growth.
H3: Human Capital is a contributing factor to the strengthening of the positive correlation relationship between Financial Development and Economic Growth.