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In what ways does human capital Financial

development
influence the relationship between and economic
growth
financial development and
economic growth?
Shekhar Saroj, Rajesh Kumar Shastri, Priyanka Singh, Received 2 March 2023
Revised 22 April 2023
Mano Ashish Tripathi and Sanjukta Dutta Accepted 29 April 2023
Department of Humanities and Social Sciences,
Motilal Nehru National Institute of Technology Allahabad, Prayagraj, India, and
Akriti Chaubey
Symbiosis Institute of Business Management Pune,
Symbiosis International (Deemed University), Pune, India

Abstract
Purpose – Human capital is a portfolio of rich skills that the labour possesses. Human capital has attracted
significant attention from scholars. Nevertheless, empirical findings on the utility of human capital have often
been divided. To address the research gap in the literature, the authors attempt to understand how human
capital plays a significant role in financial development and economic growth nexus.
Design/methodology/approach – The authors rely on secondary data published by the World Bank. The
authors use econometric tools such as the autoregressive distributive lag (ARDL) model and related statistical
tests to study the relationship between human capital, India’s financial growth and gross domestic product
(GDP) growth.
Findings – Study findings suggest that human capital and financial development contribute significantly to
economic growth. Further, the authors found that human capital has a positive and significant moderating
effect on the path of joining financial development and economic growth.
Practical implications – The study contributes to the human capital debate. Despite the rich body of
literature, the study based on World Bank data confirms the previous findings that investment in human
capital is always useful for the financial and economic growth of the nation.
Originality/value – This paper reveals some unique findings regarding effect of financial development and
economic growth nexus which opens the window of new dimension to think about their nexus. It also provides
a different pathway to foster the economic growth by using human capital and financial development as
together, especially in India.
Keywords Economic growth, Financial development, Human capital, Interaction effect,
Finance–growth nexus
Paper type Research paper

1. Introduction
The financial development and economic growth nexus have recently received much
attention, mainly through the physical capital accumulation channel. Still, several
determinants significantly affect economic growth (Ha and Ngoc, 2022). According to
neo-classical growth theories, the pace of saving-investment (Harrod–Domar model) or the
rate of technological advancement (Solow model) exogenously determines economic growth;
however, following the emergence of endogenous growth theory, human capital has gained
significant importance as one of the determinants of the economic growth. Human capital can
be defined as the resource with the inherent capabilities of a human being and the acquired Benchmarking: An International
Journal
knowledge, skills and educational qualifications. Human capital is an asset in the endogenous © Emerald Publishing Limited
1463-5771
theory of growth (Lucas, 1988; Romer, 1986; Barro et al., 1991; Cakar et al., 2021), and it plays a DOI 10.1108/BIJ-03-2023-0131
BIJ crucial and essential role in economic growth (Mankiw, 2021; Adeleye et al., 2022). The term
“financial system”refers to the collection of institutions that make up the global financial
system, such as central banks, stock exchanges, bond markets and commercial banks.
A strong and stable financial system is a key driver of economic expansion at the macrolevel
by more effectively allocating resources and channelling them toward the most
productive uses.
When the financial system is more reliable and secure, it encourages greater investment
and savings, which in turn creates more physical capital and boosts economic growth
(Levine, 2021). According to Diamond (1984), there is a substantial correlation between
economic expansion and the numerous indicators of financial progress. King and Levine’s
(1993) study of Schumpeter’s theory suggests that financial institutions contribute to the
quickening of economic growth as well (King and Levine, 1993; Hakeem, 2010). Human
capital, monetary progress and international economic expansion have all been studied
separately. Fischer (1991) revealed that transition countries benefit significantly more than
other countries. According to studies cited in Diamond and Dybvig (1983), a growing
economy cannot succeed without investing in its people; hence, a stable financial system is
crucial. They also asserted that people with higher levels of education are more likely to be
financially stable, willing to take calculated risks and knowledgeable about economics.
Shrotriya and Dhir (2018) have discussed the importance of the quality of human capital is
essential for sound economic growth. Therefore, advancing one’s educational status might
pave the way to greater financial independence. The more educated a population is, the easier
it is for them to use financial services. Financial services allow for more human capital
accumulation, which in turn increases economic growth (Mendoza et al., 2022). Because of
their combined impact, education and financial advancement have a more significant bearing
on gross domestic product (GDP) growth (Gupta et al., 2022). Some scholars based on their
studies concluded that the stock market could not be used as a predictor of future
performance (see, Chakraborty, 2010; Cabral and Dhar, 2019). The investment in human
capital and the capital-output ratio were positively cointegrated with GDP growth (Cabral
and Dhar, 2019). Human capital is thus one of the most important and positive enablers of
growth in an economy (Bhattacharya, 2020). Also, it has been found that investment in
human capital promotes sustainable growth in the economy (Yong et al., 2022). Although
recent studies have acknowledged the role of human capital on the economic growth of the
nation, it remains unexplored in the existing literature on “what”, “why” and “how” investment
in human capital have differential effects on the economic growth of the nation. To bridge the
research gaps, we have outlined our research questions (RQ1 and RQ2).
RQ1. What are the joint effects of human capital and financial development on a nation’s
economic growth?
RQ2. How the human capital and financial development linked to economic growth?
(direct or moderating effects)
To answer our research questions RQ1 and RQ2, we grounded our study in the positivism
philosophy. We have adopted longitudinal data drawn from reputable databases to test our
research hypotheses. The study’s findings provide a different perspective to understand the
endogenous growth theory and suggest different paths to reach the same destination. The
base model of endogenous growth theory focuses on physical capital accumulation through
human capital investment; later, the theory has been explored, and the nexus between
financial development and economic growth received much attention, mainly through the
physical capital accumulation channel. The unique contribution of this study is the
empirical evidence that offers a connection between financial development and economic
growth in India, mainly through the human capital accumulation channel. This paper
provides empirical evidence for academicians to understand the endogenous growth theory Financial
with new prospects and motivate them to explore new dimensions of endogenous growth development
theory. This paper also explains the relevance of human capital in defining the nexus
between financial development and economic growth in India. The results of this paper
and economic
reveal that a well-educated person contributes more to economic growth. An educated growth
person has a good understanding of the financial market; consequently, they can take
rational financial decisions to achieve financial profits or market stability in the economy.
Furthermore, a financially stable person can afford quality education for their children,
which leads to the ultimate contribution to the economic growth of a nation (Dixit et al.,
2023). Considering this, the study’s results should be of interest to scholars and Indian
policymakers to focus on quality education and financial education to boost the pace of
economic growth in India.
The study is laid out as follows: In the first section, our study hypothesis and the
overarching theoretical framework have been developed. The second section discusses the
prior research and makes a hypothesis for the study. Section 3 provides a conceptual model of
the study and research design, outlining the data description and model definition of the
planned investigation. Additional empirical results were presented, and in section 4, we
performed all the necessary analysis, which included descriptive statistics and correlation
matrix, stationarity test – an examination of the data’s nature and the model estimation.
Research findings and their theoretical and policy implication have been discussed in section
5. The limitations and future directions of our study have also been explained in this section.
Finally, section 6 concludes the paper. The overall goal of this study is to assess how human
capital and financial development affect economic growth in India. The research questions
listed below serve as the foundation for this study.

2. Theoretical background and related literature

This paper has utilized the Lucas model of endogenous growth theory as a basis to frame the
conceptual model. Romar (1986) and Lucas (1988) have explained how the endogenous factor
of production determines the economic growth in their model. According to them,
investment in human capital increases the productivity and leads to better utilization of
physical capital and consequently increases the economic growth. This paper is also inspired
to the work done by Fisher (1991) where he explained that the interaction effect of financial
development and human capital on economic growth has some alluring effects for the
dynamics of transition.
Demirg€ uç-Kunt and Asli Levine (2008) found that the financial system’s fundamental
characteristics yield sufficient information on transaction costs to support economic
expansion. The efficiency of the financial system is measured by how well its five main
functions are executed: (1) planning for capital allocation and potential investments;
(2) monitoring investments through corporate governance; (3) facilitating trade,
diversification and risk management; (4) pooling savings and mobilizing resources and
(5) easing the flow of goods and services (Demirg€
uç-Kunt and Asli Levine, 2008). Estrada et al.
(2010) and King and Levine (1993), in their empirical re-examination of the relationship
between financial development and economic growth, found that financial development has a
significant effect on per capita GDP. They argued that this is because financial development
not only increases the accumulation of physical capital but also improves an economy’s
capacity to use more physical capital. Levine and Zervos (1998) conducted an empirical study
on the finance–growth link in 47 countries from 1976 to 1993, finding that banking sector
expansion and stock market liquidity positively influenced GDP growth. Financial progress
was found to have a significant and lasting impact on economic expansion throughout South
Asian Association for Regional Cooperation countries (Sehrawat, 2016). Hanifah and Vafaei-
BIJ Zadeh (2020) have found that human social capital helps in enhancing innovation resulting
boost in economic growth. Future potential enhancements to India’s economic and financial
systems were also discussed (Sehrawat and Giri, 2015). The expanded model presented by
Mankiw and Weil (1992) showed how monetary innovation might lead to economic
expansion. From 1975 to 2000, data from 15 Organisation for Economic Co-operation and
Development (OECD) countries and 50 non-OECD countries were used in panel-integration
and co-integration analyses (Apergis et al., 2007) to evaluate the correlation between financial
development and economic growth over the long term. They discovered an unheard-of long-
run equilibrium connection between financial innovation and economic expansion, all else
being equal. They also discovered a mutually reinforcing association between progress in the
financial sector and overall economic expansion. Kagzi and Guha (2018) found that diversity
in human capital has a positive linear relationship with a firm’s performance in the Indian
economy.
Evidence supports the theory that advancing the financial sector would boost GDP. There
is a correlation between economic expansion and the availability, penetration and use of
financial services (Sharma, 2016). The extent of entrepreneurship in the Indian economy is
positively correlated with financial inclusion (Goel and Madan, 2019).The quantity of
deposits and loans was shown to have a one-way link with GDP, but the extent of a country’s
geographic footprint was found to have a two-way association with economic growth, as
determined by a Granger causality study. The findings supported the merit of piloting social
banking programmes at India’s leading financial institutions. Advanced dynamic common-
correlated estimator (DCCE) and panel Granger causality tests were used to panel data from
22 developing nations between 1980 and 2020 (Minh et al., 2021). They also claimed that the
Granger principle established a two-way causal link between economic growth and financial
development.
Financial and economic growth in underdeveloped nations has been studied using the
endogenous growth theory (Masoud and Hardaker, 2012). This supports the theory that
financial development helps in driving economic growth. Thus, our first proposed hypothesis
is as follows
H1. There is a significant impact of financial development on economic growth.
Numerous studies have been conducted to ascertain the role of factors such as physical
capital, financial development, FDI, inflation, international trade and institutional quality
in driving economic expansion. Economic expansion is shown to be positively influenced
by the stock of human capital, and it has recently been found that the same is true of
physical capital (Romer, 1986; Barro et al., 1991; Lucas, 1988; Mankiw and Weil, 1992).
Their study found a positive association between the number of patents and the level of
secondary education, they also found a negative correlation between the amount spent on
education and GDP per capita. This result jibes with the results of a separate study
(Nonneman and Patrick, 1996), which indicated that spending on education dampens
economic expansion. Education and economic growth, as well as health and economic
growth, are two of the most common topics studied (Ogundari and Awokuse, 2018).
Therefore, they examined the connection between rising educational and health standards
as surrogates for human capital. However, research in sub-Saharan Africa looked at how
climate and economic growth can affect human capital. It was discovered that the
connection between human capital and GDP growth varies with the country’s degree of
economic development. Greater investment in human capital is one factor that helps propel
economies in countries with high per capita income. Nations with lower incomes have
lower literacy rates than countries in the upper income category. The failure to make
education accessible and inexpensive contributes to a low literacy rate, which in turn
reduces human capital production. Also, the poor stock of human capital hinders economic
expansion in nations where investments are inadequate. Sub-Saharan Africa was the Financial
focus of a study by Akinlo and Oyeleke (2020), who looked at the correlation between development
human capital measures like education levels and things like life expectancy. In addition,
they utilized the combined number of people in school and the workforce as a proxy for
and economic
human capital to investigate its correlation with economic growth, yielding more accurate growth
estimates. They also looked into whether or not economic expansion modifies the
correlation between GDP and human capital using the World Bank’s definitions of low,
middle and high income, and the study found that the impact of human capital on
economic growth was stronger in high-income groups than in low-income groups. This led
them to the conclusion that economic development is contingent on the impact of human
capital on growth. From the above studies, our hypothesis is proposed as follows:
H2. There is a positive and significant effect of human capital on economic growth.
Human capital has been found to have a positive correlation with financial development in
forecasting economic growth across a panel of 82 countries over a period of 21 years (Evans
et al., 2002). This study analysed the effect of human capital on GDP expansion. Studying the
research of Montiel (2011), we learn that boosting financial development and increasing
physical and human resources can help speed up economic progress. According to Abubakar
et al. (2015), the ratio of total currency in circulation to GDP has little bearing on GDP growth.
Furthermore, the activities of financial intermediaries improve human capital, which has
significantly benefited the GDP growth in the Economic Community of West African States
area. There was an examination of the long- and short-term effects of financial development,
human capital and GDP growth in sub-Saharan Africa (Ibrahim, 2018). Also, he theorised that
a country’s economy might expand rapidly if it had a high human capital baseline to begin
with and then employed cutting-edge technology to keep it there. The increase in financial
resources and human capital is associated with higher GDP growth (Sarwar et al., 2021). The
effect of human capital on India’s economic expansion between 1999 and 2013 was analysed
by Arora and Jalilian (2020). They looked at the correlation between human capital and state
GDP and found that it is positively correlated with financial growth and GDP expansion.
Regression analysis in the study reveals a link between human capital and financial
development, but the researchers were unable to definitively make a conclusion due to a lack
of long-term data for critical elements. In conclusion, it stands to reason that a country’s
economic output increases in tandem with its stock of human and monetary capital. Thus, our
third hypothesis is proposed as follows:
H3. There is a positive interaction effect of human capital and financial development on
economic growth.
There is a clear causal link between human capital, financial advancement and economic
growth, although past empirical research has shown inconsistent evidence for and against
this approach. The relationship between these macroeconomic variables remains an open
question, particularly for India, notwithstanding the progress made in the study of
growth. The key idea of this research is that modern theories of economic growth take into
account physical capital and human capital as important contributors to economic
development. This paper assume human capital expansion results in a larger pool of
educated and competent workers who are more likely to find employment in service
industries like the financial industry. Additionally, it is shown that those with higher
levels of education make better economic choices. As a result, human capital also affects a
nation’s economic growth. Interestingly, one study corroborates above hypothesis by
concluding that foreign direct investment in an economy does not contribute to growth
(Albassam, 2015). Economic growth changes result from the interplay between human
capital and financial progress.
BIJ 3. Research design
To test the research hypotheses, this study has conceptualized economic growth as an
endogenous variable and human capital and financial development as exogenous variables.
We have controlled the effects of some variables including gross-fixed capital formation,
foreign direct investment, inflation and trade openness to minimize the confounding effects of
these control variables on the study. We present the econometrics of the model (see, equation
(1) and equation (2)).
Main effect function:
GDPt ¼ f ðFDt þ HCt þ GFCFt þ FDIt þ INF t þ Tt Þ (1)

Interaction effect function:

GDPt ¼ f ðFDt þ HCt þ GFCFt þ FDIt þ INF t þ Tt þ FD t * HCt Þ (2)

where economic growth (GDPt) is the function of financial development (FDt), human capital
(HCt), gross-fixed capital formation (GFCFt), foreign direct investment (FDIt), inflation (INFt)
and trade openness (Tt) as denoted in Eqn. (1) and interaction terms of financial development
and human capital (FDt*HCt) in Eqn. (2).
Above functional relationship in Eqn. (1) and Eqn. (2) can also be expressed in logarithmic
forms to examine the growth effects:
Main effect log model:
lnGDPt ¼ β0 þ β1 lnFDt þ β2 lnHCt þ β3 lnGFCFt þ β4 lnFDIt þ β5 lnINF t þ β6 lnTt þ εt (3)

Interaction effect log model:

lnGDPt ¼ β0 þ β1 lnFDt þ β2 lnHCt þ β3 lnGFCFt þ β4 lnFDIt þ β5 lnINF t þ β6 lnTt
(4)
þ β8 ðlnFDt 3 lnHCt Þ þ εt

3.1 Data description

To test our research hypotheses, we used econometric tools due to the longitudinal data (time-
series) nature of the data. We used the World Development Indicators time series data, which
spans between 1993 and 2019 (with the exception of the indicator of financial development,
which comes from the DBnomics International Monetary Fund [IMF] database). Real GDP per
capita was utilized as a stand-in for economic growth in this research, with secondary school
enrolment and the financial development index serving as the key independent variables.
The Financial Development Index was used to measure progress in Financial Development
(FD), while secondary school enrolment rates were used to measure progress in HC due to
data constraint. Nine factors are used to calculate the Financial Development Index, which
provides an overall assessment of a country’s financial infrastructure in terms of its depth,
accessibility and efficacy. When taken together, the indices offer a holistic assessment of
economic growth. Foreign direct investment (FDI), trade openness (TO) and the consumer
price index for inflation (INF) served as supplementary factors. We also developed an
interaction variable by multiplying financial development by human capital (FD*HC) to look
for evidence of a synergistic effect.

3.2 Model specification

This study has utilized ARDL model proposed by Pesaran et al. (2001). It provides robust
estimates, which contain the present and lag values of the regressors as well as the lagged
values of the dependent variables. The ARDL technique has been applied in this study Financial
over the other co-integration techniques because of its robust estimation, i.e. it has development
enhanced effect with respect to smaller sample and finite sample size data and provides
unbiased long-run estimates Bhutto (2019), Syed et al. (2021a, b). Second, in the ARDL
and economic
model, endogenous and exogenous factors are combined. Third, the ARDL model helps in growth
the optimum lag selection, which provides better estimates. The ARDL model may be
utilized in the fourth case where the variables have a variety of different integration
orders, including when some variables have an integration order of I(0) and others have an
integration order of I(1) Syed et al. (2021a, b). In addition, the long-run equilibrium
estimates provided by the dynamic error-correction model (ECM) are studied in the ARDL
model (see point #5 below). These positives are balanced by the fact that the model is
useless if the variables are integrated to order I(2).
The following ARDL model is outlined:
ARDL bound test
ΔlnGDPt ¼ a0 þ Σn1
i¼1 biΔlnGDPt−1 þ Σi¼0 ciΔlnFDt−1 þ Σi¼0 diΔlnHCt−1
n2 n3

þ Σn4
i¼0 eiΔlnGFCFt−1 þ Σi¼0 fiΔlnFDIt−1 þ Σi¼0 giΔlnINF t−1 þ Σi¼0 hiΔlnTt−1
n5 n6 n7

þ Σn8
i¼0 iiΔðlnFDt−1 3 lnHCt−1 Þ þ lnGDPt−1 þ β 1 lnFDt−1 þ β 2 lnHCt−1
þ β3 lnGFCFt−1 þ β4 lnFDIt−1 þ β5 lnINF t−1 þ β7 lnTt−1
þ β8 ðlnFDt−1 3 lnHCt−1 Þ þ εt
(5)

Error-correction model (ECM)

ΔlnGDPt ¼ a0 þ Σn1
i¼1 biΔlnGDPt−1 þ Σi¼0 ciΔlnFDt−1 þ Σi¼0 diΔlnHCt−1
n2 n3

þ Σn4
i¼0 eiΔlnGFCFt−1 þ Σi¼0 fiΔlnFDIt−1 þ Σi¼0 giΔlnINF t−1
n5 n6
(6)
þ Σn7
i¼0 hiΔlnTt−1 þ Σn8
i¼0 iiΔðlnFDt−1 3 lnHCt−1 Þ þ λECMt−1 þ εt

Different variables in the following equation illustrate the dynamics of mistake correction,
while “In” expresses variables in their natural logarithmic form. Using the Akaike
Information Criterion (AIC), the lag times n1, n2, n3, . . . n8 are determined. Starting with the
ARDL model, we conduct the ARDL bound test, where the lack of co-integration (H0) is tested
against the existence of co-integration (H1). After verifying that the variables are
cointegrated, we proceed with short-run ARDL and long-run (ECM, where λ stands for the
adjustment speed parameter and ECM stands for the long-run adjustment in Eqn. (6).

4. Data analyses
4.1 Descriptive statistics
We have taken the natural logarithm of the data. Descriptive statistical analyses of the data
were presented in Table 1. Average lnGDP, lnHC, lnFD, lnGFCF, lnFDI, lnINF, lnTO and lnFD
lnHC values are 6.93, 18.33, 0.873, 3.37, 22.9, 1.82, 3.56 and 15.99, respectively. Consistent
with previous study findings on endogenous growth theory and the determinant of economic
development, Table 1 displays a positive and substantial correlation between the economic
growth (lnGDP) and all the explanatory factors. An extremely weak negative correlation
exists between lnGDP and lnINF (inflation). Except for inflation, which shows a negligible
association with HC, FD, and foreign direct investment (FDI), all the explanatory factors are
strongly and substantially connected with HC and FD. Table 1 also reveals a correlation
between economic growth and human capital. Human capital and economic growth are
 BIJ

Table 1.
Descriptive statistics
and correlation matrix
lnGDP lnHC lnFD lnGFCF lnFDI lnINF lnTO lnFD_lnHC

Mean 6.931183 18.33644 0.8730126 3.374539 22.9215 1.829221 3.565221 15.99428

Stand. Dev. 0.3883939 0.2723564 0.0903584 0.1246928 4.703305 0.4325175 0.3466354 1.515279
Min 6.328226 17.9466 1.143551 3.150978 0.287682 1.202424 2.978156 20.52285
Max 7.587188 18.69831 0.7084285 3.578308 24.38326 2.58255 4.021661 13.05678
lnGDP 1.0000
lnHC 0.9858*** 1.0000
lnFD 0.6048*** 0.5766*** 1.0000
lnGFCF 0.5412*** 0.5881*** 0.7351*** 1.0000
lnFDI 0.3927** 0.3856** 0.0729 0.0238 1.0000
lnINF 0.2344 0.1447 0.1569 0.0304 0.1420 1.0000
lnTO 0.8106*** 0.8625*** 0.6992*** 0.8865*** 0.1498 0.0294 1.0000
lnFD_lnHC 0.5004*** 0.4674** 0.9917*** 0.7023*** 0.0175 0.1460 0.6205*** 1.0000
Note(s): *** denote 1% significance level; ** denote 5% significance level
Source(s): Authors’ estimation
positively and significantly correlated, as shown by the interaction variable. Therefore, this Financial
table gives enough evidence to investigate the short and long-run association among the development
considered variables.
and economic
growth
4.2 Unit root test
To study the long-run linkages between economic growth, financial development, human
capital and other control variables, it is a precondition to find out the order of integration of
variables. The ARDL approach can be applied only if the series follows the stationarity at I(0)
or I(1) or mixed order of integration (Shahbaz, 2012). It is an important assumption to apply
ARDL approach when series are integrated at I(0) or I(1) and no variable are integrated at
order I(2) Yadav et al. (2020). To ensure the proper sequence of integration before moving
further with the ARDL model, we first employed the augmented Dicky–Fuller (ADF) and the
Phillips–Perron (P-P) test of unit root. Once it is shown that no variables are integrated to
order I (2), we can apply the ARDL model. The results of the ADF and P-P test have been
presented in Table 2.
Here, we assume the null hypothesis (H0) that there is a unit root in the dataset against the
alternative hypothesis (H1), i.e. the dataset is stationary or the absence of a unit root in the
dataset. In ADF test, all the datasets are not stationary at level I(0), except FDI, which is
stationary at a 1% of significance level. But after the first difference at I(1), all other variables
also become stationary at 5% and at a 1% of significance level. Similarly, in P-P test, only FDI
shows the presence of stationarity at level I(0) at 1% of significance level. But after the first
difference, I(1) all others variables become stationary at 1 and 5% of significance level. The
unit root test revealed that all variables are stationary at mixed orders I(0) and I(1) (0). As a
result, we can move forward with the estimation of long-run co-integration (Syed et al., 2022).

4.3 Short- and long-run effect

Confirmation of the absence of unit root and stationarity in data series fulfils the prerequisite
assumption of ARDL and allows to apply this model. The ARDL model checks the short- and
long-run cointegration among the main interest variables and control variables. Long-term
estimates that are free of bias have been calculated using the ARDL model. Long-run
co-integration between variables may be estimated using the ARDL bound test, as seen in
Table 3. At each of the specified levels of significance, if F-statistics value is greater than
upper bound I (1) of the critical value of F-statistics, then we can reject the null hypothesis (H0)
that means there is co-integration (Peasaran et al., 2001). A similar conclusion can be drawn if

Variables lnGDP lnHC lnFD lnGFCF lnFDI lnINF lnTO lnFD_lnHC

ADF test
T-stat at I(0) 1.883 1.235 3.035 0.764 5.082 1.556 0.234 3.051
P-value 0.6633 0.9031 0.1225 0.9686 0.0001 0.8092 0.9909 0.1183
T-stat at I(1) 4.032 4.684 3.605 3.027 – 3.460 2.777 3.597
P-value 0.0079 0.0007 0.0294 0.1246 – 0.0439 0.2054 0.0301
P-P test
T-stat at I(0) 1.715 1.284 2.954 0.860 5.082 1.872 0.196 2.930
P-value 0.7441 0.8919 0.1453 0.9603 0.0001 0.6690 0.9916 0.1526
T-stat at I(1) 4.254 4.685 3.447 6.591 – 5.896 4.931 3.422
P-value 0.0037 0.0007 0.0454 0.0000 – 0.0000 0.0003 0.0485
Note(s): P-value is taken on 5% significance level Table 2.
Source(s): Authors’ estimation Unit root test
BIJ the resulting t-statistics value is smaller than the upper bound significant value at each level
of significance. Table 3 of the ARDL test results presents the F-statistics value (6.28), which
exceeds the critical value at all significance thresholds except for the most stringent one.
Furthermore, the computed absolute t-statistics value is smaller than the crucial value of the
upper bound for a number of different levels of significance. This result lends weight to the
rejection of the null hypothesis and confirms the long-run co-integration among variables.
Therefore, the ECM model will be used going forward for both interim and final projections.
Table 4 displays the short- and long-run estimates from the ECM model, where the
negative and statistically significant outcome of the adjustment (ADJ) indicates long-run
convergence and co-integration among variables. In addition, this means the prior mistake
will be fixed right away. It also shows that the adjustment speed is 65.61%, as measured by
the ADJ lnGDP coefficient. Data in Table 4 demonstrate that no factors show the significant
results in the short run that means none of any variable have significant effect on economic
growth (lnGDP). Table 4 result implies that education does not significantly affect economic
growth in the short run. Hanushek and Kimko (2000), Acemoglu and Pischke (2001) and Barro
and Lee (2013) have also found the similar result in their research. Similarly, Table 4 also
depicts that financial development has an insignificant effect on economic growth in the short
run, which is also supported by some empirical work done by Levine et al. (2000) and
Demirg€ uç-Kunt and Levine (2008). However, in the long run, human capital (lnHC) has a
positive and considerable effect on economic growth (lnGDP), with a 1% increase in human
capital increasing GDP by 2.78% (Barro et al., 1991; Mankiw and Weil, 1992). In addition,
long-term effects of financial development (lnFD) demonstrate a significant effect (Demirg€ uç-
Kunt and Asli levine, 2008; Ibrahim, 2018); however, these results are negative: 1% rise in
lnFD results in 32.6% fall in GDP per capita (King and Levine, 1993; Rousseau et al., 2011).
Additionally, inflation (lnINF) has a large and unfavourable effect on GDP per person. It
demonstrates that an increase of 1% in inflation reduces GDP by 0.10%. Long-term growth in
GDP per capita is unaffected by variables such as gross fixed capital creation, FDI or trade
openness. Table 4 demonstrates the long-run moderated influence of the interaction variable
(lnFD lnHC) on the nexus of financial development and economic growth. Based on the
findings from interaction terms, the long-term impact of both financial development and

Pesaran et al. (2001) ARDL – bound test

H0: No level relationship

F-statistics 6.283
value
T-statistics 2.86
value
10% sig. level 5% sig. level 2.5% sig. level 1% sig. level
Lowe Upper Lowe Upper Lower Upper Lowe Upper
bound bound bound bound bound bound bound bound
I [0] I [1] I [0] I [1] I [0] I [1] I [0] I [1]
Critical value 2.03 3.13 2.32 3.5 2.6 3.84 2.96 4.26
F-statistics
Critical value 2.57 4.23 2.80 4.57 3.13 4.85 3.43 5.19
t-statistics
Note(s): H0: Accepted when F-statistics < Critical value for I(0) regressors
H0: Reject when F > Critical value for I(1) regressors
H0: Accepted when t > Critical value for I(0) regressors
Table 3. H0: Reject when t < Critical value for I(1) regressors
ARDL – bound test Source(s): Authors’ estimation
ARDL(1,2,2,0,1,2,2,2) regression
Financial
development
Sample: 1995–2019 No. of observation 5 25 and economic
R-squared 5 0.9420
Adj R-squared 5 0.7217 growth
Log likelihood 5 102.62463 Root MSE 5 0.0089

D.lnGDP Coeff. Std. error T P>t (95% Conf. Interval)

ADJ lnGDP L1 0.65614 0.233858 2.81 0.038 1.25729 0.05499

LR
lnHC 2.787938 0.521734 5.34 0.003 1.446778 4.129097
lnFD 32.6045 11.94707 2.73 0.041 63.3154 1.89359
lnGFCF 0.43157 0.220164 1.96 0.107 0.99752 0.134375
lnFDI 0.001768 0.002186 0.81 0.455 0.00385 0.007388
lnINF 0.10984 0.025189 4.36 0.007 0.17459 0.04509
lnTO 0.18759 0.148303 1.26 0.262 0.19364 0.568816
lnFD_lnHC 1.798577 0.658869 2.73 0.041 0.104899 3.492254
SR
lnHC
D1 0.41357 0.559053 0.74 0.493 1.85066 1.023518
LD 0.95986 0.884347 1.09 0.327 3.23315 1.313426
lnFD
D1 11.0977 7.837417 1.42 0.216 31.2444 9.049042
LD 8.884447 15.10599 0.59 0.582 29.9467 47.71563
lnFDI
D1 0.00121 0.001033 1.17 0.294 0.00387 0.001444
lnINF
D1 0.010546 0.016191 0.65 0.544 0.03107 0.052166
LD 0.01457 0.009432 1.54 0.183 0.00968 0.038815
lnTO
D1 0.05467 0.070574 0.77 0.474 0.23608 0.126749
LD 0.048866 0.042472 1.15 0.302 0.06031 0.158044
lnFD_lnHC
D1 0.579662 0.42591 1.36 0.232 0.51517 1.674497
LD 0.48682 0.833843 0.58 0.585 2.63028 1.656645

_cons 28.1023 14.21465 1.98 0.105 64.6422 8.437639 Table 4.

Source(s): Authors’ estimation ECM model

human capital on GDP per capita is 1.7%. This is consistent with prior research showing a
favourable and considerable correlation between financial advancement and economic
expansion, with the latter increasing by 1.79% points for every one percentage point of
human capital (Evans et al., 2002; Ibrahim, 2018).
4.3.1 Model diagnosis. The ARDL ECM model was applied subject to the various
econometric tests – serial correlation, heteroscedasticity and model stability. Table 5
represents the diagnostic tests and their decisions.
Table 5 shows that none of the diagnostic tests are significant at the 5% level. Breusch–
Godfrey LM (Lagrange Multiplier) test accepts the null hypothesis of no serial-correlation,
whereas Breusch–Pagan–Godfrey LM test accepts the null hypothesis of no
heteroscedasticity. The no-model-error theory is strengthened by the insignificance of
Ramsey’s RESET model. The diagnostic tests utilized indicate that the model is sufficiently
specified and follows the economic aspects of the ARDL ECM approach.
BIJ 5. Discussion
Investment in infrastructure is important, but growth in financial and human capital is even
more so for India’s economy. This study examined the role that human capital plays in the
connection between financial development and economic growth using time series data from
the World Bank Indicators and the IMF from 1993 to 2019. Economic growth was estimated
using the real GDP per capita, and its drivers were examined using the Financial
Development Index and secondary school enrolment (HC). Moderating factors, such as the
link between human capital and financial development indices, have been established. The
ARDL model was chosen because it provides more accurate estimates of model parameters
than alternative co-integration methods. Table 1 of the correlation matrix explains the
relationship between the findings and the variables. The evidence for the co-integration of the
variables is further supported by the outcomes of an ARDL bound test, which are shown in
Table 3. As shown in Table 4, the ECM may also account for the long-run convergence and
co-integration of variables.
The financial system works as a backbone of the economy. Efficient and strong financial
system shows the monetary strength of an economy. It refers the institution which deals with
monetary functions such as central and commercial banks, stock exchange, bond markets etc.
Effective financial system assures the optimal allocation of capital and channelizing them
towards most productive uses. This research paper has used the financial development index
as a proxy for financial development, consisting of nine factors which represent an overall
assessment of country’s financial infrastructure in terms of its depth, accessibility and
efficacy. It is important to consider that there is still a debate on the relationship of financial
development and economic growth. Some studies have concluded that long-term financial
development has a positive effect on economic growth, whereas others have found no
conclusive evidence or negative effect of such a relationship. The correlation matrix in
Table 1 found the strong correlation between financial development and economic growth.
But ECM model in Table 4 shows negative long-run association between financial
development and economic growth. Thus, these research findings reject the hypothesis (H1)
of positive association between financial development and economic growth in India. Some
empirical evidence also supports the findings of negative relationship between financial
development and economic growth (Rousseau et al. (2011) and Ndikumana and Boyce (2008).
The study’s methodology may be blamed for finding that financial progress dampens India’s
economic expansion. It is possible that the long-standing legacy of financial repression or the
preponderance of the state sector’s economic operations is to blame for India’s lacklustre
performance in terms of financial development. There is also a possibility that it was
triggered by the transaction costs, which were prohibitively high because of the lack of
development in the underlying infrastructure and the inefficiency of the governing financial
institutions Honohan (2008). According to the study, this unfavourable outcome results from
financial development’s propensity to benefit the wealthy and aggravate income inequality,

Test
Diagnostic test statistics P-value Diagnosis

Breusch–Godfrey serial correlation 3.0129 0.0867 Insignificant p-value refers to no serial

LM test correlation
Breusch–Pagan–Godfrey 3.9462 0.6275 Insignificant p-value refers to absence of
heteroscedasticity test heteroscedasticity
Ramsey’s RESET test 0.1523 0.65321 Insignificant p-value confirms the model is
Table 5. correctly specified
Model diagnosis Source(s): Author’s estimation
both of which can contribute to political instability and impair economic progress Financial
(Ndikumana and Boyce, 2008). The financial instability over a period in India could also be development
the reason behind the negative association between financial development and economic
growth in India. In recent decades, Indian financial system has faced many challenges
and economic
including rapid growth in non-performing loans (NLPs), especially after the global financial growth
crisis, which weakend the credit growth thus enhancing the credit to GDP gap since 2012
(MacDonald and Xu, 2022). The condition of Indian banks have drastically declined since
mid-2010s, and the resultant fall in credit growth, and these banks have been plagued by
issues with NPLs and low capital levels which have downturn the economic performance of
India. Stress in the banking sector has a greater impact on economic growth in India because
of its high level of debt and reliance on bank lending (Sutton, 2021).
Human capital deals with the intrinsic capability of human being and their knowledge
gain throughout the whole life. Education system, health infrastructure and several training
and development indicators of human capital significantly affect the determining factors of
economic growth. This research paper has also examined the association between human
capital and economic growth taking education enrolment in higher education and financial
development indicator, respectively, as a proxy variable. The correlation matrix in Table 1
found a positive and significant association between human capital and economic growth
and The ECM model in Table 4 also found the positive linear association between them.
Hence, the result of Table 1 and Table 4 proves the hypothesis (H2) (Barro et al., 1991; Mankiw
and Weil, 1992). The productivity of an educated and skilled labour is always higher than
illiterate and unskilled labour. The per capita income of educated and skilled human capital is
always greater than illiterate and unskilled labours and that is the reason skilled and
educated human capital contributes more in economic growth of their nation. Countries with
educated and skilled human capital are better in research and development activities and
technologically advanced, which boost their economic performance. Educated and skilled
people earn more and pay more taxes to their government, and they are also self-reliant which
helps the government in getting more revenue and spending less for their social welfare.
An economy cannot achieve sustained growth without investing in its people, and a
financial system cannot work efficiently when the people are unaware about its functions.
The more educated people are, the easier it is for them to use financial services. This
research paper has used human capital and financial development together and examined
the interaction effect of human capital on finance–growth nexus. The correlation matrix in
Table 1 found a positive and significant correlation of interaction variable with economic
growth and The ECM model in Table 4 has also proved the long-run linear association
between them. The ECM model provides further support for the validity of previous studies
by showing that there is a positive and substantial relationship between financial
development and human capital interaction and economic growth in India. This finding
also suggests that human capital acts as a moderator between India’s financial
development and economic growth. Montiel (2011), Evans et al. (2002), Ibrahim (2018)
and Montiel (2011). The ECM model has proved that human capital has a long-run positive
interaction effect on the finance–growth nexus. A higher level of human capital formation
encourages innovation and the development of modern technology, both of which promote
financial intermediation and hence accelerate economic growth as a whole. Additionally,
when human capital is developed through the acquisition of high-quality education, people
become more cognizant of risk analysis and may always expand their capacity for risk-
taking, boosting their credit and demand for investment. Recent research has also proved
that high human capital expands rapidly economic growth (Evans et al., 2002; Ibrahim,
2018; Sarwar et al., 2021; Arora and Jalilian, 2020). Asian Development Bank has proved in
one of its research projects that financial literacy is lifting Indian families out of their debt.
BIJ 5.1 Implications for theory
The endogenous growth theories of neo-classical identified several growth-related factors,
including human capital, institutions, international trade and consumption of government.
The amount of human capital was the most important factor that several research utilized to
determine economic growth. This study’s findings also lend support to the endogenous
macroeconomic theory that investment in human capital has a significant and beneficial
effect on economic expansion. This research study also supports the Schumpeter’s
innovation theory that banks’ actions encourage the acquisition of physical capital, the
adoption of new technologies, innovation and other factors that lead to economic progress.
Corresponding to this, the development of the financial repression theory and the insight
from the endogenous growth models stimulate the finance growth relationship and provide
an empirical foundation for it, although physical capital accumulation was acknowledged as
one of the intermediary routes to capital formation in any nation.
Despite the fact that nowadays the human capital has become the main driver of
growth in the new growth theories, any investigation of how finance affects growth must
consider the human capital channel. This study’s original contribution is the empirical
evidence revealing a link between financial development and economic growth in India
through the process of human capital accumulation. This paper suggests the new
prospects to understand the economic growth and provides an expansion of the
endogenous growth theory, which suggests achieving the same path of economic growth
with higher pace of growth.

5.2 Implications for the practitioners and policymakers

This study provides the following policy implications considering the partial and
interaction effects of human capital on the financial development and economic growth
nexus. The study suggests various kinds of policy implications to government. First, the
results imply that supporting financial development and investing in human capital can
increase economic growth rates. To raise the standard of human capital, governments
should give top priority to initiatives that incentivize spending on education and training.
The efficiency of human capital investment may also be increased by policies that support
financial inclusion and the growth of financial markets. The policymakers should give
more emphasis on the development of educational infrastructure and encourage the
programs and policies related to the enhancement of public and private investment in
education. Although the government is making a lot of investment in the public education
system, it, additionally, requires advancement and application of technology in the present
education system, considering the importance of the digital economy. It is found that
educated people have sound indulgence in financial activities; therefore, it is suggested to
improve the quality of education and increase the stock of human capital for the
enhancement of the role of financial development of economic growth in India. Prioritizing
initiatives that support financial development, such as expanding loan availability,
bolstering financial institutions, and encouraging financial sector innovation, is a task for
policymakers. As per the dynamics, the financial system is drastically moving toward
digitalization, where digital payments transfer has become essential nowadays; therefore,
the government should also emphasize more on improving digital financial literacy to
accelerate the pace of economic growth in India, thereby offsetting the lacunas due to
digital financial literacy deficiency. The findings of the study have significant
ramifications for Indian investors and companies. The results imply that spending
money on education and training can increase output and profit. Companies with access to
financial resources can also use them to finance investments in human capital and other
growth-promoting initiatives.
5.3 Limitations of the study and future research directions Financial
The major limitation of this study is the absence of appropriate proxy variables, indicating development
financial development and human capital from the Indian perspective. Since the study
concentrated solely at India, its conclusions might not be generalizable to other nations. The
and economic
study considers human capital and the economic development as the exogeneous variables. growth
However, other variables such as political stability and technical advancement that can
influence financial development and economic growth were not studied. To provide a
nuanced understanding, we recommend other econometric variables to be taken into
consideration. Further study can be done by using tailor-made data or self-generated index as
a proxy indicator of financial development and human capital in the Indian perspective.
In that case, a researcher can perform the same analysis for better estimates. A researcher can
also extend this research over the world by using panel analysis and can check the impact of
disparities of co-integration between variables among the low-, middle- and high-level-income
countries.

6. Conclusions
Knowledge, talents and abilities are all examples of human capital, and they can all be
developed further through formal and informal learning opportunities. As opposed to this,
financial development refers to the improvement and expansion of a country’s financial
infrastructure and marketplaces. There has been a lot of study into the link between financial
development and economic growth, and research is starting to show that financial
development can have a positive effect on economic growth. The subject human capital (HC)
cannot be discounted, but the connection between financial development and economic
progress is intricate. Since it can boost output, innovation and technical advancement, human
capital is crucial to a thriving economy. Human capital, by promoting resource efficiency,
creativity and technical advancement, can serve as a go-between for monetary expansion and
economic expansion.
In this study, we investigated how investing in India’s people can boost the country’s
economy. According to the results, both financial development and human capital play
important roles in driving economic growth, with the latter serving as a positive and
substantial moderator of the causal pathway connecting the two. Greater investment in
human capital is one element that helps drive economies in countries with high per capita
income, and there is evidence that advancing the finance sector would increase GDP. The
third theory proposes that the sum of a country’s human and physical capital is directly
proportional to the level of its economic production. GDP is a function of several factors,
including financial development (FDt), human capital (HCt), gross-fixed capital formation
(GFCFt), government final consumption expenditure (GCEt), foreign direct investment (FDIt),
inflation (INFt), trade openness (Tt) and the interaction terms between FDt and HCt
(FDt*HCt).
Secondary school enrolment and the financial development indicator were the primary
independent variables used to predict real GDP per capita, which stood in for economic
expansion. Robust values were obtained using the ARDL. In contrast to the positive and
sizeable impact that lnHC has on GDP per individual, lnFD and lnINF have significant and
unfavourable impacts on economic growth. The ECM model and the correlation matrix both
discovered positive linear associations when this study analysed the impact of human capital
on the finance–growth relationship in India. It follows that practitioners and policymakers
should prioritize increasing enrolments in educational institutions because human capital has
a favourable and substantial effect on GDP per capita.
Human capital plays a pivotal role in unravelling the tangled web that connects financial
advancement and economic expansion. Due to lack of education most of the people have
BIJ insufficient information about the financial system. According to the Reserve Bank of India,
only 27% of Indian adults have the minimum financial literacy. As explained in the model, the
interaction of education and financial development can accelerate the pace of economic
growth. Therefore, policymakers should think about funding initiatives to improve education
and training in order to increase both the quality and amount of human capital, which can in
turn boost economic growth and development.

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Corresponding author
Rajesh Kumar Shastri can be contacted at: rkshastri@mnnit.ac.in

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