Financial development and innovation dynamics

Veselinović, Nevena and Radonjić, Ljubivoje (2025) Financial development and innovation dynamics. Anali Ekonomskog fakulteta u Subotici. ISSN 2683-4162

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Abstract

Purpose: The paper explores the relationship between financial development and innovation performance in selected economies of the Western Balkans and Central and Eastern Europe. It aims to determine whether the combination of bank-based and market-based financial development enhances national innovation capacity in transitional contexts. Methodology: The study is based on panel data analysis covering ten countries over the period 2011–2020. It uses composite indices of financial institutions and financial markets developed by the International Monetary Fund to capture different dimensions of financial development, and the Global Innovation Index to assess innovation. To ensure methodological robustness, the study applies Feasible Generalized Least Squares, addressing heteroskedasticity, serial correlation, and cross-sectional dependence. Findings: The results reveal that both bank-oriented and market-oriented financial structures have a positive and statistically significant effect on innovation performance. Their combined effect supports the hypothesis that a balanced and integrated financial system fosters innovation in economies undergoing structural transition. Originality/value: The paper contributes to the literature by examining the dual role of financial systems in innovation development within under-researched transitional economies. It differentiates between institutional and market mechanisms and provides empirical support for their complementarity. Practical implications: The findings suggest that policy efforts to develop inclusive and diversified financial systems can strengthen national innovation ecosystems. Policymakers are encouraged to adopt reforms that enhance access to financing across both banking and capital market channels. Limitations: The study is limited by its geographic focus and the use of static models. Future research could include additional countries, dynamic modeling approaches, and qualitative assessments of financial-institutional environments.

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