Financial Development, Institutional Quality, and Economic Growth: a Panel Fixed Effects Analysis of Emerging and Advanced Economies
Year: 2026
Type: article
Abstract: Understanding why financial development promotes economic growth in some countries but not in others remains a central question in development and financial economics. This study examines the relationship between financial development, institutional quality, and economic growth, with a particular focus on whether institutional quality conditions the growth effects of financial development across emerging and advanced economies. Using an unbalanced panel of countries over the period 2015–2023, the analysis employs a two-way fixed effects framework to control for unobserved country-specific heterogeneity and common global shocks. Financial development is proxied by domestic credit to the private sector, while institutional quality is measured using a composite index constructed from the six Worldwide Governance Indicators through principal component analysis. The results indicate that financial development, in isolation, does not exert a robust effect on economic growth once fixed effects are accounted for. However, the interaction between financial development and institutional quality is positive and statistically significant, suggesting that the growth payoff from financial deepening depends critically on governance conditions. Marginal effects analysis shows that financial development is growth-enhancing only at higher levels of institutional quality, while its effect is negligible or negative in weak institutional environments. Subsample analysis reveals that this conditioning mechanism is substantially stronger in emerging economies than in advanced economies. Robustness checks using an alternative composite measure of trade openness yield qualitatively similar conclusions. The findings support a conditional view of the finance–growth nexus, highlighting the central role of institutional quality in enabling financial development to translate into sustained economic growth.
Source: Research
Institution: Universidad Autónoma del Estado de México
Language: English
Domain: Social Sciences
Open Access status: hybrid
OpenAlex ID: W7130856556
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