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Capital Inflows and Investment

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  • Pels

    ()
    (Institute for International Integration Studies, Trinity College Dublin)

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.

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Bibliographic Info

Paper provided by IIIS in its series The Institute for International Integration Studies Discussion Paper Series with number iiisdp330.

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Length: 31 pages
Date of creation: Jul 2010
Date of revision:
Handle: RePEc:iis:dispap:iiisdp330

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Keywords: capital inflows; domestic investment; financial integration;

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