1. Introduction
Digitalization has grown rapidly over the last few decades. According to the
World Bank (
2021), only 4.6% of the world’s population used the internet in 1999, compared to 25.5% in 2009 and 56.7% in 2019. Furthermore, there were 8.1 mobile cellular subscriptions per 100 people in 1999, compared to 67.5 per 100 people in 2009, while in 2019, on average, every person had more than one mobile cellular subscription (109.5 per 100 people).
However, digitalization emerged at different speeds across the world. Developed countries started rapidly adopting new technologies as early as the beginning of the century, while emerging economies have been rapidly catching up in recent years. For example, in Europe, according to the
European Commission (
2021), a clear gap has been observed between the Western, more developed, and Eastern, emerging, countries. In 2021, and in line with previous years, Denmark, Finland, and Sweden have been ranked the EU countries with the most advanced digital economies, with Romania and Bulgaria at the opposite end of the spectrum. This held true across nearly all four dimensions captured by DESI—human capital, connectivity, integration of digital technology, and digital public services.
Despite the growing number of people participating in the digital world by using new technologies,
Donou-Adonsou (
2019) argues that appropriate levels of education are required to achieve the full benefits of a digital economy. There is a long-standing debate in literature on the relationship between education, digitalization, and economic growth, the latter of which is different from financial development. For example,
Habibi and Zabardast (
2020) provides evidence from OECD countries that improvements in technology can lead to economic growth, and that education can improve the outcome of individuals.
Jepsen and Drahokoupil (
2017) provide an alternative opinion, that digitalization could have a negative impact on economic growth because digitalization could first replace unskilled, repetitive, jobs, which tend to be more abundant in emerging economies. Thus, depending on countries’ income levels, technological innovation could have an inconsistent impact on economic growth. Furthermore,
Stiglitz and Greenwald (
2015) discussed at length how technology innovation, rather than capital accumulation, leads to better standards of living. Further, improving information transparency and improving the levels of education greatly increases economic growth.
The causal relationship between financial development and economic growth is still debated in the literature. For example,
McKinnon (
1973),
Galbis (
1977),
Mathieson (
1980), and
Balassa (
1990) argue that a “liberalized” financial system will increase savings and distribute money to more productive uses, hence increasing economic growth. This liberal outlook inspired the IMF and World Bank in the early 1900s (
Luintel and Khan 1999). Several writers have shown that financial intermediaries can aid economic growth by improving resource allocation and monitoring (
Diamond 1984;
Bose and Cothren 1996;
Morales 2003;
Levine 2005). However, others question the role of finance in economic growth. Financial markets develop once the economy reaches an intermediate stage of expansion, according to
Kuznets (
1955), while
Lucas (
1988) believes financial matters are over-emphasized when discussing economic growth. Thus, finance becomes the handmaiden of business, responding to increased demand for financial services as the economy expands. The relationship between financial development and economic growth is a two-way street, according to
Lewis (
1954) and
Patrick (
1966). This latter author defined the supply leading (financial development causes economic growth) and demand following (economic growth causes financial development) processes as bi-directional. It should also be mentioned that several endogenous growth models highlight the link between financial development and economic growth (
Berthelemy and Varoudakis 1995;
Greenwood and Smith 1997).
However, we find that the link of education and technological development to financial development, which is different, from economic growth, albeit connected, has not been adequately explored, and our paper is aiming to fill this gap in two ways. First, it adds to the scarce body of European literature on education and financial development. Second, to the best of our knowledge, there has been no comprehensive study to date exploring the link financial development has with education and digitalization. Where available, existing literature has instead focused on the impact from economic growth, financial inclusion, or human development. Our paper aims to fill this gap.
Our main research hypothesis postulates that there is a strong link between education, digitalization, and financial development in Europe. Our secondary research hypothesis proposes that there are relevant geographical differences between the Western, more developed, and Eastern, emerging, economies. While developed countries are nearing their full potential regarding digitalization levels, education, and financial development, emerging countries still have a significant growth potential. Many emerging European countries have seen high levels of digitalization in recent years, but less progress has been made regarding the levels of education and financial development. This emphasizes the relevance of our research, as our findings clearly demonstrate the dynamic interaction between financial development—including its two main components, financial institutions and financial markets, digitalization, and education, but also that education is a leading variable in the financial development–education–digitalization nexus, whereas financial development and digitalization are laggard variables. These findings provide avenues to influence policies on digitalization, education, and financial development, particularly in emerging European countries.
The next section discusses in turn the links between digitalization, financial development, and education, as they appear in existing literature. The rest of the paper is structured as follows.
Section 3 discusses the data and methodology used in our analysis, including any limitations.
Section 4 presents the results of our model and
Section 5 discusses these results and their implication on our research hypotheses. Finally, the last section highlights the main conclusions and presents avenues for future research.
4. Results
The descriptive statistics in
Table 2 contain several patterns of the financial development–education–digitalization nexus in Europe that are useful to explore before revealing the results of the BPVAR model. In terms of financial development, our sample of countries shows higher medians for FDI, FII, and FMI compared to the values for all countries both at the beginning and ending of the time frame: in 1996, 0.43 against 0.24 (FDI), 0.54 against 0.32 (FII), and 0.31 against 0.15 (FMI); in 2019, 0.57 against 0.32 (FDI), 0.65 against 0.42 (FII), and 0.51 against 0.21 (FMI). Moreover, most European countries in our sample have seen their overall level of financial development (measured by FDI) increase between 1996 and 2019, ranging between 0.6% (Netherlands) and 106.2% (Croatia)—see
Figure 1. The exceptions are Bulgaria and Ireland, with drops of 14.2% and 0.1%, respectively. Furthermore, the median growth in FDI between 1996 and 2019 for the Eastern European countries was higher than the median for the developed countries—39.5% versus 28%—suggesting a faster financial development process in the former. However, this is unsurprising, given the significantly lower FDI level in 1996 for Eastern countries compared to Western—0.26 versus 0.51. Still, five countries have shown FDI levels below the all-countries levels both in 1996 and 2019 (Estonia, Latvia, Lithuania, Romania, and Slovakia), indicating that their progress in terms of financial development is lingering.
The results for our sample are intriguing when financial development is divided into institutional improvement and financial market progress. Both financial institutions and markets, such as the FDI, have shown clear progress over time at the sample level, with medians of 21.7 percent and 63.4 percent, respectively. However, this is a progress in diversity, as seven Western countries saw their financial institutions’ level decline between 1996 and 2019 (Cyprus, Denmark, Germany, Greece, Ireland, Netherlands, and Portugal), while several Eastern countries (Bulgaria, Poland, Romania, Russia, Slovenia, and Switzerland) saw significant falls in their financial market development.
Figure 2 depicts the common evolution of financial institutions and markets for all the countries in our sample from 1996 to 2019, and evidences a negative correlation between the two variables. Moreover, countries in Eastern Europe were characterized by significant increases in financial institution development but slower, or even negative, progress in financial markets. Between 1996 and 2019, the median rise in FII for Eastern countries was 75.8% versus 5.7% for Western countries, while the median increase in FMI for the former was 33.3% compared to 70.3% for the latter.
Turning to education, all countries in the sample have experienced increases in the Education Index (EDI), with an overall median growth between 1996 and 2019 at a sample level of 21.6% and no significant difference between Eastern countries (22.5%) and Western economies (21.0%), but slightly higher for Eastern countries. However, five Eastern economies recorded EDI values below the sample median both in 1996 (0.71) and 2019 (0.88)—Bulgaria, Croatia, Hungary, Romania, and Russia, while others (Czechia, Latvia, and Lithuania) raised their EDI level above the sample median in 2019 after being below the median in 1996. Slovakia is the only Eastern country with an EDI value above the median in 1996 but below the median in 2019, albeit with an increase in EDI of 15% over the period. Interestingly, a few developed economies also had EDI levels below the sample median in 1996 and 2019 (Austria, Cyprus, Greece, Italy, Luxembourg, Malta, Portugal, and Spain), joined by France in 2019.
By far, the most impressive evolution between 1996 and 2019 was recorded by digitalization, proxied by the number of mobile cellular subscriptions per 100 people (MOB). At sample level, MOB increased from a median of 5.72 in 1996 to 122.26 in 2019 (a 1939% increase over the period), but the process was almost ten times more pronounced in Eastern countries than in Western countries, as the former reached a median in 2019 almost equal to the one for Western countries (121.71 over 123.72) while starting at a much lower level in 1996 (a median of 1.28 versus 8.69). Hence, Eastern countries’ growth in mobile subscriptions was 10,593.6% between 1996 and 2019 against only 1235.7% for Western economies. This suggests that digitalization may be used as a highly powered channel for economic development in these countries, given its ubiquitous presence in individuals’ everyday lives.
When we assemble the evolution of all three components of the financial development–education–digitalization nexus over the time frame of our analysis, interesting observations emerge.
Figure 3 shows their interaction in 1996 and 2019—the two axes indicate the EDI and MOB levels, while the size of the bubble shows the FDI dimension in each year. Eastern countries form a rather well-established cluster in 1996, which has as its main attributes the low level of digitalization compared to Western economies but an overall lower level of education that matched the one in many Western countries (except for Belgium, Netherlands, United Kingdom, and Germany). The leading position of Iceland and United Kingdom on the digitalization axis is also observable. Eastern countries display lower levels of financial development when compared to their Western peers, as indicated by the smaller size of the bubbles. However, the landscape changes in 2019, particularly when digitalization is considered: three Eastern countries (Lithuania, Russia, and Estonia) had mobile cellular subscriptions not matched by other European countries—168.8, 164.4, and 147.2, respectively—while in others, the number of mobile cellular subscriptions overcomes the one in many Western countries. There has also been noticeable progress in terms of education for all European countries, as outlined above, but what the right panel in
Figure 3 reveals is that the level of financial development in Eastern countries remains low compared to Western ones in 2019.
We now turn to the results of the BPVAR model.
Table 3 shows the results of panel unit root tests, which show that that our variables are I(1), except for GDP that is I(0). The null hypothesis for all tests is that series have a unit root. Therefore, we have decided to implement the BPVAR with the first difference of all variables and the level for GDP growth rate.
The Bayesian Schwartz Information Criterion (SIC) was used to determine the optimal number of lags and the test indicated 1 lag for all six panels. Further, the Dumitrescu-Hurlin panel causality test has been applied using 1 lag—results are reported in
Table 4. The test shows that bi- or uni-directional causality exists between financial development, education, and digitalization variables, which supports their inclusion in a VAR type of model. We have not tested the causality between financial development variables, given that FDI is constructed using FII and FMI, and such a test would have been irrelevant. The results evidence the bi-directional causality between FDI, FII, and FMI, and digitalization, as well as between education and digitalization. Moreover, we find uni-directional causality from education to FDI and FII, as well as from all financial development variables to GDP growth. Furthermore, TRD received the uni-directional influence (in Granger sense) of FII, and uni-directionally causes EDI.
Multicollinearity is to be avoided between the variables that enter a VAR model, as it may lead to biased estimators (
Joutz et al. 1995;
Gujarati and Porter 2009), but there is no consensus in the literature regarding the level of correlation between variables that should be avoided.
Table 5 shows the Pearson correlation coefficients for the variables included in our analysis and the only figures above 0.6 are for FDI-FII. Because the two financial development variables will not be included simultaneously in our BPVAR models, multicollinearity is not an issue of concern for our estimations.
Table 6 shows the autoregressive root results for the three panels and reveals that all estimations meet the BVAR stability (stationarity) criterion, because the AR roots have modulus lower than one and lie within the unit circle. Hence, the results of the BPVAR estimates are valid and we proceed to the analysis of impulse responses and variance decomposition results.
In addition, we present the estimated BPVAR models’ Impulse Response Functions (IRF) for financial development, education, and digitalization. Individually, these functions represent the impact of shocks originating in one variable on each of the other variables, describing the VAR system’s response to shocks through time and proving its dynamic nature given the endogeneity of variables included in the model.
Figure 4 depicts the first period’s lack of response by FDI, FII, and FMI to a one standard deviation shock (or innovation) in education, followed by a positive response in the second period (between 0.0043 for FII and 0.0050 for FMI), and a declining influence up to the eighth period. The same pattern can be seen in the responses of all financial development variables to shocks in digitalization (MOB), but the positive reaction in the second period is lower than in the first, varying between 0.0028 for FDI and 0.0037 for FMI. However, even after ten periods, the response of financial development to digitalization shocks is positive, albeit small, implying a longer-term impact of digitalization on financial development for the countries in the sample.
In the case of education (EDI), regardless of the variable chosen, all three panels show a positive first 2-period impact of one standard deviation innovations in financial development, which falls to zero after six periods. The response of education to digitalization is observable only from the second period (it is zero in the first period) and, as with financial development, there is no impact after six periods, implying that education is a type of leading variable in the financial development–education–digitalization nexus, whereas financial development and digitalization are laggard variables. This finding is supported by the response of digitalization (MOB) to one standard deviation shocks in education: positive in the first period (between 0.0076 for FDI and 0.0089 for FMI) but increasing in the second period (between 0.0123 (FDI) and 0.0140 (FMI)), followed by declines and then remaining positive after ten periods. In terms of financial development, a one standard deviation shock has a considerable impact in the first period (between 0.0064 for FMI and 0.0107 for FDI), which reduces over time but remains positive and significant after ten periods. This conclusion suggests that both financial development and education have a stimulating influence on digitalization, which is fueled by the desire for more educated people to access sophisticated financial products, platforms (therefore markets), and financial institutions.
5. Discussion
The relationship between education, digitalization, and economic growth has been thoroughly explored by existing literature, including with regards to financial inclusion and human development. However, the link with financial development has been less established, and our paper aims to fill this gap. Our empirical analysis focuses on 32 European countries during the 1996 to 2019 period, of which 27 are current European Union members. The findings highlight an overall positive association between financial development, education, and digitalization, where education is a leading variable in this triad, whereas financial development and digitalization are laggards.
Collectively, European countries have improved their levels of financial development, considering both dimensions—institutions and markets. However, the growth in financial development between 1996 and 2019 for the Eastern European countries was higher than the one for Western countries, thus suggesting a faster financial development process in the former. Certainly, this catching up was expected given the significantly lower levels of financial development in the former countries in 1996. This may be due to the private capital flows, in the form of direct and portfolio investments, attracted over time, and largely fueled by the prospective of EU accession, which often meant political and economic transition, privatization, increased opening of the economies, and financing opportunities. Thus, between 2002 and 2007 (the EU pre-accession period), CEE countries attracted one-third of all private capital inflows to emerging markets (
Kattel 2010), which contributed to their building of capital stock and fast growth. The presence of foreign capital providers also fueled a learning process within domestic financial markets participants, which further incentivized financial institutions and markets to develop (
Henry 2000;
Bekaert et al. 2007;
Otchere et al. 2016). Moreover,
Bayar and Gavriletea (
2018),
Henri et al. (
2019), and
Majeed et al. (
2021) support the view that higher levels of financial development attract foreign investments, which leads to the existence of a virtuous foreign capital–financial development cycle.
However, some of these countries have shown financial development levels below the all-countries levels both in 1996 and 2019, which may be the effect of their lower ability to attract foreign capital flows. This negatively impacted their progress in terms of financial development. An interesting explanation of these countries’ lower progress in financial development may rely on their bank-centric financial systems, which
Ivanisevic Hernaus and Stojanovic (
2015) argue are typical of CEE countries. Furthermore,
Bats and Houben (
2020) show that financial systems that rely more on financial markets are more efficient, provide investors with more diversified opportunities, and can sustain a lower exposure to systemic risk. However, these countries’ financial development evolution has different roots; Estonia and Latvia’s financial institutions development was less rapid than their financial market development, while the reverse is true for Lithuania, Romania, and Slovakia, with Romania showing a decline in financial market development.
Hence, for completeness, it is necessary to consider both components of financial development. We observe differences when financial development is divided into institutional improvement and financial market progress. Some Western countries saw their financial institutions’ level decline between 1996 and 2019, while several Eastern countries saw significant falls in their financial market development. These results are in line with
Chinn and Ito (
2006) and
Khera et al. (
2021) stating that the quality of financial institutions is one of the key drivers for improving financial development.
Furthermore, according to (
Fratzscher 2012;
Różański and Sekuła 2016;
Kurul and Yalta 2017), institutions and their quality are major factors of capital inflows, including the link between foreign capital and financial market development. Referring to the latter, recent financial markets’ deregulation strongly encouraged the development of financial markets and their integration at regional and global levels (
Rajan and Zingales 2003). In the European Union in particular, the introduction of the euro (EUR) in 1999 led to increased financial markets integration, as evidenced by
Bartram et al. (
2007),
Horobet and Lupu (
2009),
Mylonidis and Kollias (
2010),
Grossman and Leblond (
2011), and
Vukovic et al. (
2017), although on a slower pace after the 2007 global financial crisis (
Pungulescu 2013).
According to
Savva and Aslanidis (
2010), the former communist countries that are currently European Union members have been part of the financial integration process, with beneficial effects for their financial markets’ development. However, two of the CEE countries, Bulgaria and Romania, have seen their financial market development level significantly drop between 1996 and 2019, which may be explained by their joining of the EU just before the 2007 global financial crisis and the European sovereign debt crisis in 2011–2012 (
Moagăr-Poladian et al. 2019).
However, we observe that Bulgaria and Romania are the European laggards in almost all measures of financial market development. For example, the ratio of bank deposits to GDP for these two countries was 67.72% and 31.61%, respectively, in 2017 (the latest year with available data from IMF), substantially lower than 82.14% for Germany (in 2017) or 171.25% for Switzerland (in 2016), according to the Federal Reserve Bank of St. Louis (FRED). When analyzing capital markets, the other main component of financial markets, Bulgaria had a ratio of market capitalization to GDP of 23.19% in 2020 and Romania a ratio of 14.6%, according to IMF and CEIC data, compared to an overall 54.6% ratio for the European Union in 2018.
Another possible explanation for the declines observed in financial markets’ development is IMF’s calculation of the index values, which are not absolute values, but the result of a normalization procedure applied to the raw set of indicators used to build these indexes (
Svirydzenka 2016). Hence their lower values in 2019 compared to 1996 may indicate that these countries’ markets have not been able to keep up with the rest of the world. Nevertheless, this is a warning sign for policy makers in these countries, as they need to identify and implement strategies meant at increasing the relevance and usefulness of financial markets for the real economy.
With regards to education development, our results suggest that all countries in our sample experienced increases over our time frame. Although there were no significant differences between Eastern and Western economies, we found that education plays a leading role in both financial development and digitalization. This supports
Donou-Adonsou’s (
2019) conclusion that a lack of education is one of the main reasons why developing countries may not be fully reaping the benefits of digitalization. Given that many Eastern countries underwent several social and political changes during this period and a transition from centralized to market-based economies, they require a highly skilled and knowledgeable population to increase overall prosperity. Our results also support education as the intermediary between financial development and economic growth (
Levine 2005;
Beck et al. 2010;
Čihák et al. 2012;
or Benos and Zotou 2014).
Between 1996 and 2019, digitalization demonstrated the most impressive evolution, with the process being more pronounced in Eastern countries than in Western ones. Thus, digitalization may be used as a highly powered channel for financial and economic development in these countries, given its pervasive presence in individuals’ everyday lives. In 1996, Eastern countries evidenced much lower levels of digitalization compared to Western economies, but the gap had shrunk substantially by 2019. To this end,
Jepsen and Drahokoupil (
2017) present evidence that CEE countries are likely to be affected differently by digitalization than more developed countries. Whilst education levels across Europe also improved by 2019, the discrepancies in 1996 were much less significant. This highlights the importance of education in retraining the workforce in preparation for an increasingly digital world.
Our research found that financial development responds positively to digitalization shocks, meaning that digitalization will have a longer-term impact on financial development. Our findings are consistent with
Feyen et al. (
2021), in that digitization has not only lowered transaction costs but also fostered the emergence of new fintech business models.
Overall, we suggest several areas that require development policies concerning the acquiring of a better level of education to fully benefit from an increasingly digital society. The global financial crisis has demonstrated the extent and speed of contagion to the real economy, highlighting the need for prudential oversight of financial institutions. The development of macro-prudential policies that safeguard the integrity and transparency of financial markets remains critical. Alignment of countries outside the Eurozone with EU’s financial markets could improve economic stability and prosperity. Our findings reveal that some European countries’ financial development levels fell below the global median both in 1996 and 2019. For this reason, it is critical for policymakers to design safe and sound financial institutions and not just simply increase the number of individual banks in less developed Eastern European countries. This is because low overall banking assets result in non-performing loans and inefficient resource allocation (
Jaffee and Levonian 2001). Instead, central banks could consider improving interest margins or domestic credit provision to the private sector. In turn, these measures could attract foreign capital flows.
Furthermore, it is vital that Eastern European countries continue to accelerate their digitalization by embarking on initiatives supporting the EU’s goal of creating a digital single market and strengthening its global digital leadership (
Mnohoghitnei et al. 2021). Governments and the private sector should collaborate to create the appropriate structures for the transposition of European laws into national law. Moreover, emerging countries should take advantage of the infrastructure and technological support offered by the fact that their market players, notably in finance, are already connected to the most developed countries via European electronic networks.
To ensure a robust educational framework, research and development should be prioritized to support the development of a qualified and specialized workforce. Our findings demonstrate that education should be used to guide future policies in order to accelerate economic progress.
6. Conclusions
This paper empirically examines the link between financial development, education, and digitalization, by analyzing a group of 32 European countries during 1996 and 2019, of which 27 are current European Union members. We used a Bayesian panel VAR (BPVAR) model, which suits our sample and research objectives. Aside from the expected finding that there is a dynamic interdependence between financial development, digitalization, and education, a highly interesting result is that education is the leading variable in the nexus, while financial development and digitalization are laggard variables. These findings pave the way for the development of concurrent policies and strategies on digitalization, education, and financial development, particularly in emerging European countries where financial development is significantly lower than in more developed peers. Thus, our findings point to direct support for financial markets and institutions, owing to increased diversity of financial products and greater access to them by individuals and businesses, which will eventually lead to deeper markets and more efficient institutions. These will eventually increase the integration of emerging European financial markets into developed European markets, benefiting both consumers and businesses. Furthermore, financial development can be aided by investment in education, which can target various segments of the population, including lower income or elder populations.
Finally, digitalization may be a critical component of a successful education strategy, as its ubiquitous role in our lives has been clearly revealed by the current pandemic. The ongoing pandemic is causing significant changes in society, with ramifications for the economy, the environment, and the population, but especially for the role of innovation and technology. The pandemic provides opportunities for significant reforms and investments in digital infrastructure and technology. To build a more sustainable Europe for future generations, the EU adopted the Next Generation EU European Recovery Plan in December 2020, which aims to assist Member States in dealing with the consequences of the pandemic while also assisting the EU economy in recovering in a greener, digital, and resilient direction. However, this will not be an easy path, particularly in emerging European countries, because digital development necessitates both the modernization of teaching methods and educational systems, as well as significant streamlining of administrative processes. Thus, given the EU’s goal of building a single digital market, it is important to study the potential risks to the competitiveness and development of the digital economy in the context of economies that have not reached the digital maturity stage. Moreover, by identifying gaps, opportunities, and challenges from the perspective of integration into the digitalized single market, one good question is whether the attractiveness of emerging markets as a model of consumer and outsourcing markets will increase.
Certainly, our research has limitations that are inherent to the model, variables used, and time frame of the analysis, all of which are highly dependent on data availability. Based on our findings, several future research directions may be explored, including an investigation of the relationship between financial market development and institutional development (not just financial institutions), an examination of how businesses’ level of digitalization relates to financial development, and a more in-depth analysis of the level of education and its impact on financial and economic development. Moreover, studies on the joint reinforcement of education, digitalization, and financial development through targeted policies are highly relevant.