Financial development and economic complexity: The mediating role of institutional quality

Abstract

This study aims to examine the role of institutional quality in explaining the adjustment of the relationship between economic complexity and financial development in high- and low-income economies between 1990 and 2024. To this end, a panel dataset balanced is tested with the Cross-Sectionally Augmented Autoregressive Distributed Lag (CS-ARDL) model supplemented by robustness tests with Augmented Mean Group (AMG) estimation and Dumitrescu-Hurlin panel Granger causality tests, and institutional quality understood across five governance indicators. The findings affirm that strong institutions significantly contribute to the positive impact of economic complexity on financial development, particularly in advanced economies, where the drivers are government effectiveness, rule of law, and control of corruption, while weak institutions in poor nations constrain these impacts and slow down the conversion of financial development into productive sophistication. The conclusion of the analysis is that institutional quality is a key determinant of sustaining the finance-complexity nexus to enable financial systems to enable innovation, diversification, and long-term growth. The policy implications suggest that policymakers in high-income economies should put efforts into guaranteeing institutional resilience and adapting financial structures to technological change, whereas low-income economies must put efforts into establishing governance, eliminating corruption, and growing human capital to ensure sustainable and inclusive financial development.