Modelling Trilogies Between Financial Liberalization, Human Capital and Financial Development: Evidence from Pakistan Using Threshold Model Approach

This article investigates the relationship between financial liberalization and financial development in Pakistan, using human capital as a threshold variable over the period 1972–2023. The research finds that human capital must reach a value of 1.66 for overall financial liberalization to effectively take place. To gain deeper insights, the study decomposes overall financial liberalization into internal and external components. The estimated threshold values of human capital are 1.66 for internal and 1.53 for external financial liberalization. The results show that financial development is hindered when external financial liberalization remains below the human capital threshold, whereas the opposite effect is observed for internal financial liberalization. Once the human capital surpasses the threshold, both internal financial liberalization and external financial liberalization, as well as overall financial liberalization, positively contribute to financial development in Pakistan. These findings confirm that the positive relationship between financial liberalization and financial development is conditional upon reaching a specific threshold level of human capital. However, the relatively small magnitudes associated with each type of financial liberalization suggest that further reforms in financial sector policies are necessary. A reformed financial sector will then be better positioned to play a leading role in achieving sustainable economic growth. To this end, more focused efforts are required to improve the quality of human capital in Pakistan, ensuring its productive contribution to the finance–growth nexus. Additionally, macroeconomic variables also support financial development. Therefore, policymakers must ensure the effective utilization of physical capital stock, government expenditures and the maintenance of moderate inflation levels to foster the development of the financial sector.