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

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  • Yizhou He
  • Tae Hwan Yoo

Abstract

Financial 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.Investment is pivotal for sustaining long-term economic growth, fostering development, expanding market access, promoting innovation, and reducing transaction costs. This research aims to examine the impact of financial development on domestic investment across countries with varying income levels. Utilizing the system generalized method of moments (GMM) and the pooled mean group (PMG) estimator, the study analyzes a panel of 152 countries from 1980 to 2021. The findings reveal a positive influence of financial development on investment performance, particularly up to a certain threshold in the long run. Importantly, as countries’ income levels rise, the significance of financial development on investment performance becomes more pronounced in low- and middle-income countries. However, with the deepening of the financial sector, its effect on domestic investment may eventually diminish. These results underscore the importance of considering the optimal level of financial development to foster investment growth.

Suggested Citation

  • Yizhou He & Tae Hwan Yoo, 2024. "Financial development impact on domestic investment: does income level matter?," Cogent Economics & Finance, Taylor & Francis Journals, vol. 12(1), pages 2321811-232, December.
    • Handle: RePEc:taf:oaefxx:v:12:y:2024:i:1:p:2321811
    DOI: 10.1080/23322039.2024.2321811
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