Capital Inflows and Investment

Barbara Pels

The Institute for International Integration Studies Discussion Paper Series from IIIS

Abstract: According to neoclassical economic theory capital scarce countries with an open capital account will attract foreign capital because the rate of return in these countries is high. Capital inflows will be channelled towards investment projects in order to reap the benefits of the higher rate of return, and this will lead to economic growth. Empirically it is not clear that this mechanism is at work. This paper extends the current literature by combining the insight that domestic finance matters for growth into the empirical literature on the effects of capital inflows. A panel of 39 countries between 1976 and 2003 is used to estimate the effects of capital inflows on fixed investment. I use panel data on 39 developing countries between 1976 and 2003 to show that the effect of capital inflows on physical investment depends on the type of flow and on the level of domestic financial development. It is shown that the effect of capital inflows on physical investment depends on the type of flow and on the level of domestic financial development. The effects of aggregate capital inflows on investment are positive, small and increasing with the level of domestic financial development. Only for debt inflows there is an indication that a higher level of financial development increases the effect the inflows have on investment.

Keywords: capital inflows; domestic investment; financial integration (search for similar items in EconPapers)
JEL-codes: F21 F30 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2010-07
New Economics Papers: this item is included in nep-ifn
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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