Does financial development spur labor productivity? Evidence on the moderating roles of FDI and capital accumulation

Abstract

Purpose Financial development (FD) facilitates economic growth by improving resource efficiency and potentially boosting labor productivity (LP). This study aims to examine the association between LP and FD, foreign direct investment (FDI) and capital formation, while also assessing their moderating effects. Design/methodology/approach The study uses panel data regression to estimate the impact of FD, FDI and capital formation on LP across 82 developed and developing economies from 1991 to 2023. To address potential issues in the econometric analysis and ensure robustness, the study conducted a panel-data regression with clustered robust standard errors. Findings The analysis shows that domestic credit and capital formation significantly boost LP across all income levels. Surprisingly, FDI appears to negatively moderate the relationship between FD and LP. This dampening effect is more pronounced in developing economies compared to developed ones. Additionally, while capital formation negatively moderates the relationship in developing economies, it positively influences it in developed economies. Originality/value Studies to date have largely focused on the impact of FD on economic growth, thereby obscuring its specific impact on LP. This study focuses specifically on the FD-LP relationship. Moreover, none of the studies have analyzed the moderating impact of FDI and gross capital formation on this relationship. Thus, this study focuses on their moderating effects on the FD-LP relationship and explores their differential impact across developed and developing countries. Highlights Graphical abstract A informational graphic outlining study objectives, methodology, and findings regarding labor productivity. The informational graphic is organized into a header, two side-by-side horizontal text boxes, and four vertical text boxes. The top dark blue header contains the title “Does Financial Development Spur Labor Productivity? Evidence on the Moderating Roles of F D I and Capital Accumulation”. Below this, two boxes are placed side by side. The left text box states “1. This study aims to explore the association of labor productivity with financial development, foreign direct investment, and capital formation”. The right box states “2. This study seeks to address the critical empirical gap by explicitly examining the moderating roles of F D I and G C F in shaping the financial development and labor productivity nexus”. The four vertical text boxes are present below, titled “Research Objectives (Inputs)”, “Research Methodology”, “Key Findings (Outputs)”, and “Policy Implications”. Under “Research Objectives (Inputs)”, labels include “Financial Development (Domestic credit)”, “Foreign Direct Investment (F D I)”, and “Gross Capital Formation (G C F)”. “Research Methodology” lists “Panel Data Regression (1990 to 2023)”, “Countries equals 82”, and “Techniques: Fixed Effect slash Random Effect”. “Key Findings (Outputs)” list “Positive Effects” noting “Credit and G C F improve labor productivity” and “Neutral slash Negative Effects” noting “No impact of F D I” and “The moderating effects of F D I and G C F vary across developed and developing economies”. “Policy Implications” state “Well-functioning financial systems are key to raising labor productivity” and “Complementary policies on investment efficiency and absorptive capacity are needed in developing economies”. A bottom footer text box states “Conclusion: The availability of finance is very crucial for improving labor productivity”.