The Transformation of Economic Structure in Developing Countries: Evidence of Financial Development as a Source of Financing

ABSTRACT This article examines the influence of financial development (FD) on the transformation of the economic structure in 89 developing countries (21 low‐income countries and 68 middle‐income countries) during 1996–2018. Different FD indicators are grouped and ungrouped: FD, financial institutions (FI) and financial markets (FM), each assessed through depth (FID, FMD), access (FIA, FMA) and efficiency (FIE, FME). An Economic Structure Transformation Index (ESTI) encompasses four dimensions: manufacturing, manufacturing trade, innovation and manufacturing employment. Empirical results demonstrate that FD stimulates economic transformation. Moreover, the mediation analysis reveals that FD not only has a direct positive effect on the transformation of the economic structure but also has a positive indirect effect through its impact on agricultural productivity, digitalization of the economy, and commercial openness. To accelerate the positive effects of FD on the transformation of the economic structure, governments should formulate policies aimed at improving productivity in the agricultural sector, thereby encouraging the migration of surplus labour from this sector to the manufacturing sector. Additionally, promoting the digitalization of the economy would be beneficial for fostering the adoption of advanced technologies. Furthermore, encouraging commercial openness aims to enhance the production and quality of goods and services by exploiting comparative advantages between countries.