When Capital Markets Work Best: The Joint Role of Institutions and Digitalization in Economic Growth

This study investigates if a developed capital market impacts equally on overall growth across the EU or if it varies according to the general structural conditions. We employ a two-way fixed-effects panel for all EU countries to analysis the relationship between a composite capital market index and GDP per capita growth and explicitly model the conditioning roles of both institution quality and digital readiness. Our baseline estimates indicate that the independent effect of capital market development is low and negative (on average); however, the negative independent impact of capital markets is mitigated by incorporating the influence of institutional quality and digital readiness. Our core conclusion is that there is substantial positive and robust interaction between capital market development and digital readiness; therefore, the importance of capital markets to growth will increase as the economy’s capacity to operate digitally increases. However, the interaction between capital market development and institution quality is not consistently statistically significant across specifications. The results of further analyses show that the digital moderation pattern remains stable, indicating that the composition and quality of how private capital is allocated have a consistently negative relationship with growth, which means that how well and how much you finance your activities is far more important than simply having access to a large amount of money through outputs or inputs such as stocks or bonds. There is also support for a conditional interpretation of the finance-growth connection and digital readiness as the major mechanism used to translate capital market development into real economic performance within the EU.