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

Figures & data

Figure 1. Effect of financial development on investment growth. Data source: International Bank.

Figure 2. Scatter plot of GNI per capita and financial development by income group. Data source: International Monetary Fund, World Bank.

Table

Country (income group)	FD	FI	FM	Country (income group)	FD	FI	FM
AGO (MI)	0.1392	0.2490	0.0241	JPN (HI)	0.8876	0.8848	0.8557
ALB (MI)	0.2034	0.3905	0.0082	KAZ (MI)	0.3542	0.4572	0.2373
ARE (HI)	0.4860	0.3676	0.5852	KEN (MI)	0.1646	0.2850	0.0378
ARG (MI)	0.3061	0.3788	0.2213	KGZ (MI)	0.1359	0.2590	0.0076
ARM (MI)	0.2621	0.4908	0.0230	KHM (MI)	0.2097	0.4096	0.0016
ATG (HI)	0.2800	0.5490	0.0000	KIR (MI)	0.0994	0.1949	0.0000
AUS (HI)	0.9086	0.9129	0.8688	KOR (HI)	0.8181	0.8518	0.7523
AUT (HI)	0.6584	0.7398	0.5511	LAO (MI)	0.1700	0.2459	0.0873
AZE (MI)	0.2530	0.2885	0.2076	LBN (MI)	0.3020	0.4496	0.1424
BDI (LI)	0.1686	0.2369	0.0936	LBY (MI)	0.1282	0.2513	0.0000
BEL (HI)	0.6320	0.7527	0.4865	LKA (MI)	0.2612	0.3423	0.1699
BEN (MI)	0.1104	0.2067	0.0098	LTU (HI)	0.1965	0.3584	0.0270
BFA (LI)	0.1245	0.2435	0.0007	LUX (HI)	0.7076	0.8232	0.5644
BGD (MI)	0.2432	0.2869	0.1899	LVA (HI)	0.2121	0.3819	0.0340
BGR (MI)	0.3787	0.6733	0.0692	MAC (HI)	0.4852	0.8573	0.0941
BHR (HI)	0.4639	0.3465	0.5632	MAR (MI)	0.3513	0.4330	0.2559
BHS (HI)	0.4947	0.6481	0.3219	MDA (MI)	0.2295	0.4467	0.0033
BIH (MI)	0.2657	0.5187	0.0022	MDG (LI)	0.1062	0.2048	0.0033
BLR (MI)	0.1654	0.3076	0.0168	MEX (MI)	0.4017	0.4654	0.3223
BLZ (MI)	0.2175	0.4195	0.0070	MKD (MI)	0.2603	0.5062	0.0042
BOL (MI)	0.3915	0.7584	0.0093	MLI (LI)	0.1231	0.2382	0.0032
BRA (MI)	0.6618	0.6429	0.6547	MLT (HI)	0.5176	0.6419	0.3730
BRB (HI)	0.3990	0.5727	0.2097	MNG (MI)	0.3084	0.4937	0.1109
BRN (HI)	0.3249	0.4628	0.1743	MOZ (LI)	0.1550	0.2082	0.0956
BTN (MI)	0.2266	0.4281	0.0162	MRT (MI)	0.1333	0.2558	0.0057
BWA (MI)	0.3451	0.4494	0.2272	MUS (MI)	0.4934	0.5122	0.4552
CAF (LI)	0.0416	0.0815	0.0000	MYS (MI)	0.7271	0.6982	0.7275
CAN (HI)	0.8738	0.9595	0.7539	NAM (MI)	0.4024	0.7231	0.0660
CHE (HI)	0.9393	0.9204	0.9213	NER (LI)	0.1122	0.2104	0.0097
CHL (HI)	0.5041	0.5936	0.3947	NGA (MI)	0.2206	0.2359	0.1967
CHN (MI)	0.6339	0.6075	0.6354	NLD (HI)	0.7089	0.6310	0.7590
CIV (MI)	0.1283	0.2042	0.0474	NOR (HI)	0.6360	0.5506	0.6966
CMR (MI)	0.1014	0.1960	0.0028	NPL (MI)	0.2131	0.4172	0.0006
COD (LI)	0.0661	0.1297	0.0000	NZL (HI)	0.6174	0.7390	0.4716
COG (MI)	0.0931	0.1649	0.0176	OMN (HI)	0.3836	0.4095	0.3427
COL (MI)	0.3878	0.4581	0.3023	PAK (MI)	0.2196	0.2908	0.1398
COM (MI)	0.0568	0.1114	0.0000	PAN (HI)	0.4650	0.5147	0.3971
CRI (MI)	0.2880	0.5357	0.0289	PER (MI)	0.3744	0.5136	0.2205
CYP (HI)	0.5080	0.5584	0.4376	PHL (MI)	0.3791	0.3799	0.3635
CZE (HI)	0.3169	0.5186	0.1027	PNG (MI)	0.1837	0.2614	0.0987
DEU (HI)	0.7021	0.6206	0.7560	POL (HI)	0.4309	0.4825	0.3623
DNK (HI)	0.6646	0.7367	0.5665	PRT (HI)	0.6539	0.7291	0.5531
DOM (MI)	0.1837	0.3443	0.0158	PRY (MI)	0.1933	0.3217	0.0573
DZA (MI)	0.1409	0.2746	0.0017	ROU (HI)	0.2753	0.4685	0.0713
ECU (MI)	0.1700	0.3085	0.0249	RUS (MI)	0.5299	0.6000	0.4389
EGY (MI)	0.3088	0.3185	0.2870	RWA (LI)	0.1595	0.2795	0.0331
ERI (LI)	0.0887	0.1739	0.0000	SAU (HI)	0.4420	0.3487	0.5180
ESP (HI)	0.8035	0.7759	0.7996	SDN (LI)	0.1075	0.2107	0.0002
EST (HI)	0.2524	0.4439	0.0510	SEN (MI)	0.1190	0.2217	0.0116
FIN (HI)	0.6457	0.6126	0.6534	SGP (HI)	0.7039	0.7606	0.6196
FJI (MI)	0.2179	0.4255	0.0017	SLB (MI)	0.0996	0.1954	0.0000
FRA (HI)	0.8149	0.8468	0.7510	SLE (LI)	0.0704	0.1332	0.0049
GAB (MI)	0.1219	0.2280	0.0109	SLV (MI)	0.2138	0.3902	0.0290
GBR (HI)	0.8363	0.7856	0.8541	SRB (MI)	0.2558	0.4470	0.0546
GEO (MI)	0.3327	0.6194	0.0330	SVK (HI)	0.2804	0.5250	0.0248
GHA (MI)	0.1784	0.2457	0.1041	SVN (HI)	0.3237	0.5441	0.0907
GIN (MI)	0.1070	0.1968	0.0129	SWE (HI)	0.7753	0.7387	0.7815
GMB (LI)	0.1073	0.2104	0.0000	SWZ (MI)	0.1839	0.3484	0.0122
GNB (LI)	0.0953	0.1868	0.0000	SYC (HI)	0.3540	0.6224	0.0717
GRC (HI)	0.4735	0.4300	0.4985	SYR (LI)	0.1220	0.2392	0.0000
GTM (MI)	0.2158	0.4092	0.0139	TCD (LI)	0.0702	0.1083	0.0293
GUY (HI)	0.1473	0.2834	0.0054	TGO (LI)	0.1776	0.2491	0.0992
HKG (HI)	0.7597	0.7932	0.6964	THA (MI)	0.7314	0.7103	0.7237
HND (MI)	0.2103	0.3423	0.0700	TJK (MI)	0.1065	0.2061	0.0027
HRV (HI)	0.4682	0.6810	0.2370	TLS (MI)	0.1025	0.2009	0.0000
HTI (MI)	0.0980	0.1923	0.0000	TON (MI)	0.2350	0.4608	0.0000
HUN (HI)	0.4644	0.5266	0.3840	TUN (MI)	0.2349	0.4051	0.0555
IDN (MI)	0.3644	0.4104	0.3041	TUR (MI)	0.4996	0.4166	0.5630
IND (MI)	0.5336	0.4640	0.5822	TZA (MI)	0.1027	0.1886	0.0128
IRL (HI)	0.6245	0.5866	0.6380	UGA (LI)	0.1041	0.2014	0.0028
IRN (MI)	0.5222	0.5998	0.4242	UKR (MI)	0.2070	0.3704	0.0355
ISL (HI)	0.4961	0.7011	0.2717	URY (HI)	0.3044	0.5637	0.0332
ISR (HI)	0.6045	0.7645	0.4209	USA (HI)	0.9170	0.8982	0.8999
ITA (HI)	0.7670	0.7218	0.7821	UZB (MI)	0.2860	0.5107	0.0501
JAM (MI)	0.3559	0.5542	0.1436	VUT (MI)	0.1966	0.3855	0.0000
JOR (MI)	0.3591	0.4641	0.2400	ZAF (MI)	0.5456	0.5778	0.4920

Notes: Region and income groups are designated according to the World Bank classification of countries. Low-income (LI) economies are defined as those with a gross national income (GNI) per capita of $1085 or less in 2022, calculated using the World Bank Atlas method; Middle-income (MI) economies are defined as lower-middle-income economies, those with a GNI per capita between $1086 and $4255, and upper-middle-income economies, those with a GNI per capita between $4256 and $13,205; High-income (HI) economies are those with a GNI per capita of $13,206 or more.

Table 1. Description of variables.

Variable	Description
${\mathit{\text{INV}}}_{\mathit{\text{it}}}$	Gross fixed capital formation as a percentage of GDP in country i at time t.
${\mathit{\text{FD}}}_{\mathit{\text{it}}}$	A comprehensive index of financial development in country i at time t.
${\mathit{\text{FI}}}_{\mathit{\text{it}}}$	An index of financial institutions, including the indicators of financial depth, access, and efficiency (sub-index of financial development), in country i at time t.
${\mathit{\text{GDP}}}_{\mathit{\text{it}}}$	The annual growth rate of real GDP per capita in country i at time t.
${\mathit{\text{OPEN}}}_{\mathit{\text{it}}}$	Total imports plus exports as a percentage of GDP in country i at time t.
${\mathit{\text{GOV}}}_{\mathit{\text{it}}}$	General government final consumption expenditure as a percentage of GDP in country i at time t.
${\mathit{\text{FDI}}}_{\mathit{\text{it}}}$	Foreign direct investment net inflows as a percentage of GDP in country i at time t.

Data source: International Monetary Fund Database and the World Development Indicators.

Table 2. Panel unit root tests results.

Variables	IPS Test		Fisher-ADF		PP test		Status
	Statistic	p-Value	Statistic	p-Value	Statistic	p-Value
${\mathit{\text{INV}}}_{\mathit{\text{it}}}$	−10.2335	0.0000	1052.6348	0.0000	576.6962	0.0000	I(0)
${\mathit{\text{FD}}}_{\mathit{\text{it}}}$	−0.3323	0.3698	872.6036	0.0000	352.4694	0.0289	I(1)
$\Delta {\mathit{\text{FD}}}_{\mathit{\text{it}}}$	−58.9005	0.0000	2006.3321	0.0000	5570.4746	0.0000
${\mathit{\text{GDP}}}_{\mathit{\text{it}}}$	−46.3275	0.0000	1735.5745	0.0000	3549.4136	0.0000	I(0)
${\mathit{\text{OPEN}}}_{\mathit{\text{it}}}$	−3.1969	0.0007	871.8831	0.0000	464.5654	0.0000	I(0)
${\mathit{\text{GOV}}}_{\mathit{\text{it}}}$	−8.3311	0.0000	1077.4249	0.0000	590.3522	0.0000	I(0)
${\mathit{\text{FDI}}}_{\mathit{\text{it}}}$	−17.3410	0.0000	1094.1564	0.0000	1411.9188	0.0000	I(0)

Table 3. Kao residual panel cointegration results.

Test	t-Statistic	p-Value
Modified Dickey–Fuller	−9.7897	0.0000
Dickey–Fuller	−9.2813	0.0000
Augmented Dickey–Fuller	−7.9705	0.0000

Table 4. Empirical results for the basic model.

Variable	(1) OLS	(2) Fixed effects model	(3) System GMM
${\mathit{\text{INV}}}_{\mathit{\text{it}}-1}$			0.6047***
			(0.0641)
${\mathit{\text{FD}}}_{\mathit{\text{it}}}$	0.7865***	0.4489***	1.3651***
	(0.0812)	(0.1206)	(0.4151)
${\mathit{\text{FD}}}_{\mathit{\text{it}}}^2$	−0.6648***	−0.7643***	−1.3261***
	(0.0917)	(0.1163)	(0.4218)
${\mathit{\text{GDP}}}_{\mathit{\text{it}}}$	0.0426***	0.0123***	0.0098*
	(0.0050)	(0.0042)	(0.0052)
${\mathit{\text{OPEN}}}_{\mathit{\text{it}}}$	0.0767***	0.2016***	0.1980**
	(0.0101)	(0.0186)	(0.0821)
${\mathit{\text{GOV}}}_{\mathit{\text{it}}}$	0.0119	−0.0756***	−0.0206
	(0.0126)	(0.0208)	(0.1641)
${\mathit{\text{FDI}}}_{\mathit{\text{it}}}$	0.0056	0.0261***	0.0113
	(0.0040)	(0.0035)	(0.0070)
$\mathit{\text{Cons}}$	2.6603***	2.383***	0.1957
	(0.0635)	(0.0889)	(0.6541)
Number of observations	3804	3804	3740
Number of countries	152	152	152
R-squared	0.121	0.079
Sargan test^a			148.33
			(0.717)
AR(2)^b			0.700

Notes: ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively. Standard errors are reported in parentheses. (a) The null hypothesis of the Sargan test is that overidentifying restrictions are valid. (b) The null hypothesis of the Arellano-Bond test is that there is no autocorrelation. OLS: ordinary least squares; GMM: generalized method of moments.

Table 5. Empirical results for short and long run effects.

Variable	(4) Short run effect	(5) Long run effect
${\mathit{\text{FD}}}_{\mathit{\text{it}}}$		11.6467*** (3.0532)
${\mathit{\text{FD}}}_{\mathit{\text{it}}}^2$		−8.0640** (2.6561)
${\mathit{\text{GDP}}}_{\mathit{\text{it}}}$		1.3124*** (0.0637)
${\mathit{\text{OPEN}}}_{\mathit{\text{it}}}$		−0.0015 (0.0065)
${\mathit{\text{GOV}}}_{\mathit{\text{it}}}$		−0.0321 (0.0546)
${\mathit{\text{FDI}}}_{\mathit{\text{it}}}$		−0.0093 (0.0086)
$\mathit{\text{ECT}}$	−0.1816*** (0.0101)
${\Delta \mathit{\text{INV}}}_{i,t-1}$	0.1250*** (0.0185)
${\Delta \mathit{\text{FD}}}_{\mathit{\text{it}}}$	−0.6611 (6.0351)
${\Delta \mathit{\text{GDP}}}_{\mathit{\text{it}}}$	−0.0808*** (0.0135)
${\Delta \mathit{\text{OPEN}}}_{\mathit{\text{it}}}$	0.0601*** (0.0096)
$\Delta {\mathit{\text{GOV}}}_{\mathit{\text{it}}}$	0.1646*** (0.0466)
${\Delta \mathit{\text{FDI}}}_{\mathit{\text{it}}}$	0.0898** (0.0322)
$\mathit{\text{Con}}$	3.3965*** (0.2591)

Notes: ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively. Standard errors are reported in parentheses.

Table 6. Empirical results by income group.

Variable	Low- and middle-income countries		High-income countries
	(6) Fixed effects model	(7) System GMM	(8) Fixed effects model	(9) System GMM
${\mathit{\text{INV}}}_{\mathit{\text{it}}-1}$		0.4962***		0.7481***
		(0.1237)		(0.1111)
${\mathit{\text{FD}}}_{\mathit{\text{it}}}$	0.5532**	2.3739**	0.4163***	1.5002***
	(0.2155)	(1.0035)	(0.1481)	(0.5303)
${\mathit{\text{FD}}}_{\mathit{\text{it}}}^2$	−1.1510***	−3.0032**	−0.4482***	−1.1911***
	(0.3078)	(1.3088)	(0.1303)	(0.4324)
${\mathit{\text{GDP}}}_{\mathit{\text{it}}}$	0.0151***	0.0045	0.0007	0.0034
	(0.0056)	(0.0123)	(0.0055)	(0.0107)
${\mathit{\text{OPEN}}}_{\mathit{\text{it}}}$	0.2797***	0.1571	−0.0374	0.0991
	(0.0243)	(0.1095)	(0.0266)	(0.0709)
${\mathit{\text{GOV}}}_{\mathit{\text{it}}}$	−0.0326	−0.1429	−0.4438***	0.4813*
	(0.0249)	(0.2880)	(0.0422)	(0.4813)
${\mathit{\text{FDI}}}_{\mathit{\text{it}}}$	0.0304***	0.0399*	0.0101**	0.0336***
	(0.0046)	(0.0206)	(0.0048)	(0.0113)
$\mathit{\text{Cons}}$	1.9224***	0.9442	4.4889***	−1.4518
	(0.1091)	(0.5706)	(0.1704)	(1.2884)
Number of observations	2385	2349	1419	1391
Number of countries	99	99	53	53
R-squared	0.115		0.102
Sargan test^a		41.07		76.32
		(1.000)		(0.341)
AR(2)^b		0.517		0.367

Notes: ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively. Standard errors are reported in parentheses. (a) The null hypothesis of the Sargan test is that overidentifying restrictions are valid. (b) The null hypothesis of the Arellano–Bond test is that there is no autocorrelation. GMM: generalized method of moments.

Table 7. Robustness test using proxy variables.

(10) System GMM based on lagged FD (${\mathit{\text{FD}}}_{\mathit{i},\mathit{t}-1})$		(11) System GMM based on FI (${\mathit{\text{FI}}}_{\mathit{i},\mathit{t}})$
${\mathit{\text{INV}}}_{i,t-1}$	0.6239***	${\mathit{\text{INV}}}_{i,t-1}$	0.6303***
	(0.0640)		(0.0663)
${\mathit{\text{FD}}}_{i,t-1}$	1.1981***	${\mathit{\text{FI}}}_{\mathit{\text{it}}}$	1.3210**
	(0.4214)		(0.5840)
${\mathit{\text{FD}}}_{i,t-1}^2$	−1.1749***	${\mathit{\text{FI}}}_{\mathit{\text{it}}}^2$	−1.2100**
	(0.4326)		(0.5503)
${\mathit{\text{GDP}}}_{\mathit{\text{it}}}$	0.00926*	${\mathit{\text{GDP}}}_{\mathit{\text{it}}}$	0.0111**
	(0.0051)		(0.0049)
${\mathit{\text{OPEN}}}_{\mathit{\text{it}}}$	0.1992**	${\mathit{\text{OPEN}}}_{\mathit{\text{it}}}$	0.2387***
	(0.0830)		(0.0832)
${\mathit{\text{GOV}}}_{\mathit{\text{it}}}$	0.0008	${\mathit{\text{GOV}}}_{\mathit{\text{it}}}$	0.0606
	(0.1611)		(0.1523)
${\mathit{\text{FDI}}}_{\mathit{\text{it}}}$	0.0108	${\mathit{\text{FDI}}}_{\mathit{\text{it}}}$	0.0130*
	(0.0069)		(0.0069)
$\mathit{\text{Cons}}$	0.1072	$\mathit{\text{Cons}}$	−0.3168
	(0.6454)		(0.6117)
Number of observations	3740	Number of observations	3740
Number of countries	152	Number of countries	152
Sargan test^a	152.78	Sargan test	165.00
	(0.624)		(0.356)
AR(2)^b	0.744	AR(2)	0.683

Notes: ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively. Standard errors are reported in parentheses. (a) The null hypothesis of the Sargan test is that overidentifying restrictions are valid. (b) The null hypothesis of the Arellano-Bond test is that there is no autocorrelation. GMM: generalized method of moments.

Table 8. Robustness test for short and long run effects.

Variable	(12) Short run effect	(13) Long run effect
${\mathit{\text{FD}}}_{\mathit{\text{it}}}$		15.4406*** (3.1192)
${\mathit{\text{FD}}}_{\mathit{\text{it}}}^2$		−12.0986** (2.7760)
${\mathit{\text{GDP}}}_{\mathit{\text{it}}}$		1.2472*** (0.0591)
${\mathit{\text{OPEN}}}_{\mathit{\text{it}}}$		−0.0043 (0.0059)
${\mathit{\text{GOV}}}_{\mathit{\text{it}}}$		−0.0457 (0.0518)
${\mathit{\text{FDI}}}_{\mathit{\text{it}}}$		−0.0106 (0.0080)
$\mathit{\text{ECT}}$	−0.1875*** (0.0108)
${\Delta \mathit{\text{INV}}}_{i,t-1}$	0.1298*** (0.0181)
${\Delta \mathit{\text{FD}}}_{\mathit{\text{it}}}$	0.4741 (3.3772)
${\Delta \mathit{\text{GDP}}}_{\mathit{\text{it}}}$	−0.0794*** (0.0136)
${\Delta \mathit{\text{OPEN}}}_{\mathit{\text{it}}}$	0.0618*** (0.0097)
$\Delta {\mathit{\text{GOV}}}_{\mathit{\text{it}}}$	0.1608*** (0.0454)
${\Delta \mathit{\text{FDI}}}_{\mathit{\text{it}}}$	0.0892** (0.0340)
$\mathit{\text{Con}}$	3.3751*** (0.2677)

Notes: ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively. Standard errors are reported in parentheses.

Table 9. Robustness test by income group.

Variable	System GMM based on lagged FD (${\mathit{\text{FD}}}_{\mathit{i},\mathit{t}-1})$		System GMM based on FI (${\mathit{\text{FI}}}_{\mathit{i},\mathit{t}})$
	(14) Low- and Middle-Income Countries	(15) High-Income Countries	(16) Low- and Middle-Income Countries	(17) High-Income Countries
${\mathit{\text{INV}}}_{i,t-1}$	0.6109***	0.7140***	0.4446***	0.7367***
	(0.1011)	(0.1075)	(0.1354)	(0.1082)
${\mathit{\text{FD}}}_{i,t-1}$	1.1630***	0.0273
	(0.4151)	(0.1403)
${\mathit{\text{FD}}}_{i,t-1}^2$	−1.4063**	0.2377
	(0.5502)	(0.1457)
${\mathit{\text{FI}}}_{\mathit{\text{it}}}$			3.4707**	2.0373*
			(1.4948)	(1.0556)
${\mathit{\text{FI}}}_{\mathit{\text{it}}}^2$			−3.8057**	−1.5090*
			(1.7640)	(0.8154)
${\mathit{\text{GDP}}}_{\mathit{\text{it}}}$	0.0169	0.0083	0.0069	0.0043
	(0.0119)	(0.0089)	(0.0118)	(0.0112)
${\mathit{\text{OPEN}}}_{\mathit{\text{it}}}$	0.0800	0.0206	0.1328	0.0518
	(0.1231)	(0.0573)	(0.1146)	(0.0694)
${\mathit{\text{GOV}}}_{\mathit{\text{it}}}$	−0.0223	0.0926	−0.1499	0.4231
	(0.3463)	(0.2336)	(0.2638)	(0.2702)
${\mathit{\text{FDI}}}_{\mathit{\text{it}}}$	0.0366*	0.0119*	0.0383*	0.0370***
	(0.0220)	(0.0068)	(0.0211)	(0.0116)
$\mathit{\text{Cons}}$	0.7410	0.4474	0.9193	−1.2652
	(0.8957)	(1.1453)	(0.8160)	(1.2834)
Number of observations	2349	1391	2349	1391
Number of countries	99	53	99	53
Sargan test^a	40.69	80.22	37.32	78.77
	(1.000)	(0.212)	(1.000)	(0.273)
AR(2)^b	0.612	0.208	0.490	0.620

Notes: ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively. Standard errors are reported in parentheses. (a) The null hypothesis of the Sargan test is that overidentifying restrictions are valid. (b) The null hypothesis of the Arellano-Bond test is that there is no autocorrelation. GMM: generalized method of moments.

Data availability statement

The datasets generated and/or analyzed during the current study are available from the corresponding author upon reasonable request.