The Nexus between Financial Development and Economic Growth in Pakistan: Role of Foreign Direct Investment and Market Capitalization

Abstract

This study explores the association of financial development, market capitalization, foreign direct investment, human capital, and economic growth in Pakistan. Utilizing the Autoregressive Distributed Lag (ARDL) model, the analysis draws on data spanning the period from 1995 to 2023. The main objective is to check how financial development influences the economic growth of Pakistan. The outcomes show that market capitalization and foreign direct investment have positive and substantial effects on growth in the long run. Human capital also positively influences the growth of the economy. Pakistan should strengthen capital markets, attract FDI, and invest in human capital to boost growth. Sustainable financial policies are also needed to mitigate long-term adverse effects from rapid financial development. The study results emphasize that policymakers must expand economic growth by reducing regulatory barriers, strengthening capital markets to boost investor confidence, and attracting FDI through robust protections for foreign investors to ensure a high return. Additionally, investment in human capital, particularly through education policies that provide skills and training to the labor force, is essential for sustainable development.