Financial development impact on domestic investment: does income level matter?

Abstract

AbstractFinancial development significantly bolsters a country’s economic growth and resilience. Despite increasing focus on the relationship between financial development and economic growth, few studies examine the impact of financial development on domestic investment across countries’ income levels. Therefore, this study employs the system Generalized Method of Moments estimator and the Pooled Mean Group estimator to investigate this relationship, utilizing a panel of 152 countries from 1980 to 2021. The empirical findings affirm that financial development positively influences investment performance until a specific threshold over time. However, while increasing financial development benefits investment, further deepening the financial sector may eventually diminish its impact on domestic investment. Specifically, the benefit of investment growth remains valid only up to a threshold of 0.5147, beyond which it becomes a hindrance. In the short run, financial development changes do not substantially impact investment. Additionally, the marginal effect of financial development on investment is more pronounced in low- and middle-income countries. These empirical findings provide valuable reference for enhancing financial development to foster investment growth.

Keywords

• Financial development
• financial institution
• domestic investment
• income level
• system GMM and PMG estimator
• E20