This study examines the impact of financial inclusion on the relationship between innovation and economic growth in 53 developing countries over the period 2004–2023. Given the role of financial inclusion in facilitating access to financial resources and promoting innovation, as well as the strong link between these variables and sustainable economic growth, this study seeks to better understand their interactive effects in selected developing countries. For this purpose, the Panel Smooth Transition Regression (PSTR) model is employed. The estimation results indicate a nonlinear relationship among the variables under investigation. The threshold value of the transition variable (the logarithm of the financial inclusion index) is estimated at 4.3035, with a slope parameter of 19.9284. The findings indicate that financial inclusion and innovation exert positive and statistically significant effects on economic growth in both regimes, namely, at low and high levels of financial inclusion. Urbanization has a negative and significant impact on economic growth in the first regime; however, after crossing the threshold and entering the second regime, this effect diminishes but remains negative. The ratio of non-performing loans to gross loans, used as an indicator of financial stability, has a positive effect on economic growth in the first regime, but its impact gradually weakens and becomes negative in the second regime. Inflation negatively affects economic growth in both regimes. Based on these findings, policies aimed at improving financial inclusion, supporting innovation, controlling inflation, and enhancing financial stability should be prioritized.
Purpose/Aims:
Digital financial inclusion overcomes the limitations of physical borders through the cross-border integration of digital technologies and financial services, enabling the provision of financial services across regions. On the one hand, digital financial inclusion substantially reduces transportation and transaction costs; on the other hand, it effectively lowers barriers to access and expands the coverage of financial services, allowing a larger share of the population to benefit from them. By leveraging digital advantages, digital financial inclusion helps address information asymmetry, expands the service capacity of financial markets, and improves the provision of finance to small and micro enterprises as well as individuals, thereby enabling broader access to financial services at lower costs (Wang et al., 2022).
Therefore, considering the importance of financial inclusion for economic growth and the nonlinear relationship among financial inclusion, innovation, and economic growth, this study employs the Panel Smooth Transition Regression (PSTR) model, which is one of the most prominent regime-switching models. The PSTR model is used to analyze the nonlinear and indirect effects of financial inclusion on the relationship between innovation and economic growth over the period 2004–2023. In this regard, the theoretical foundations related to the topic are first examined, followed by a review of relevant empirical studies. Subsequently, the proposed model is estimated and analyzed, and the conclusions are presented.
Methodology & Framework:        
The PSTR approach has been shown to effectively capture different types of nonlinearities, including sharp or smooth transitions between regimes, without requiring prior information about structural changes in the transition variable. Moreover, the PSTR model addresses key econometric issues such as heterogeneity and time variability by allowing parameters to vary smoothly across cross-sectional units and over time (Wang & Wei, 2019).
Accordingly, the PSTR approach is particularly suitable for modeling heterogeneous effects arising from different levels of financial inclusion when examining its impact on the relationship between innovation and economic growth in selected developing countries. The present study aims to investigate the indirect and threshold effects of financial inclusion on the relationship between innovation and economic growth in 53 developing countries over the period 2004–2023, using a nonlinear econometric framework based on the PSTR technique.
The general model, adapted from the studies of Timer & Raza (2023), Karim et al. (2022), Feng et al. (2023), Wang et al. (2022), and My Thi Thi et al. (2024), is specified as follows:
LGDPP=F (LINCLUS, LINNO, LNONPER, INF, UPG, LGOVR) (7)
where LGDPP denotes economic growth; LINCLUS represents the financial inclusion index; LINNO denotes the innovation index; LNONPER represents the financial stability index (measured as the ratio of non-performing loans to gross loans); INF denotes the inflation rate; LGOVR represents government effectiveness (governance index); and UPG denotes urbanization growth.
Findings:
To examine the stationarity properties of the variables, the Levine–Lin–Chu (LLC) unit root test is employed. The LLC test results, reported in Table 2, indicate that all variables are stationary in levels at the 1% significance level. The findings show that, in both regimes—low and high levels of financial inclusion—the effect of financial inclusion on economic growth in developing countries is positive and statistically significant. This result is consistent with the findings of Rezazadeh et al. (2023), Karim et al. (2022), Feng et al. (2023), Wang et al. (2022), and theoretical expectations. The results further indicate that innovation has a positive and significant effect on economic growth in both regimes, which is consistent with the findings of Nasiri-Aghdam et al. (2011), Wang et al. (2022), and My Thi Thi et al. (2024), as well as with theoretical foundations.
Discussion:
The results also indicate that, in the first regime characterized by low levels of financial inclusion, inflation has a negative effect on economic growth in developing countries. This negative effect intensifies after the threshold is crossed and the second regime is entered, which is consistent with theoretical expectations.
In the first regime, urbanization growth has a negative and significant impact on economic growth in developing countries. After crossing the threshold and entering the second regime, this negative effect diminishes but remains statistically significant. This finding is consistent with the results reported by My Thi Thi et al. (2024) and with theoretical considerations.
In the first regime, the effect of the ratio of non-performing loans to gross loans (financial stability index) on economic growth is positive but statistically insignificant. After crossing the threshold and entering the second regime, this effect decreases and becomes negative. These findings are consistent with theoretical expectations for developing countries, although they differ from the results reported by Zhang et al. (2022), which focus on developed economies.
Finally, the results indicate that government effectiveness (governance index) has a positive effect on economic growth in the first regime, and although this effect decreases after crossing the threshold and entering the second regime, it remains positive. This finding is consistent with the results of My Thi Thi et al. (2024).
Conclusion:
This study investigates the impact of financial inclusion on the relationship between innovation and economic growth in 53 developing countries over the period 2004–2023. Given the role of financial inclusion in facilitating access to financial resources and promoting innovation, as well as its close connection with sustainable economic growth, the study seeks to provide a deeper understanding of the interactive effects of these variables in developing economies. Using the Panel Smooth Transition Regression (PSTR) model, the results reveal a nonlinear relationship among the variables examined. The estimated threshold value of the transition variable (logarithm of the financial inclusion index) is 4.3035, with a slope parameter of 19.9284. The findings indicate that financial inclusion and innovation have positive and statistically significant effects on economic growth in both regimes, corresponding to low and high levels of financial inclusion.
Urbanization negatively affects economic growth in the first regime, and although this effect weakens after the threshold is crossed, it remains negative in the second regime. The ratio of non-performing loans to gross loans has a positive effect on economic growth in the first regime, but its impact diminishes and becomes negative in the second regime. Inflation negatively affects economic growth in both regimes. Based on these findings, policies aimed at enhancing financial inclusion, supporting innovation, controlling inflation, and strengthening financial stability should be given priority.