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Capital Inflows and Investment

  • Pels


    (Institute for International Integration Studies, Trinity College Dublin)

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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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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  1. Sebnem Kalemli-Ozcan & Laura Alfaro & Selin Sayek & Areendam Chanda, 2002. "FDI and Economic Growth: The Role of Local Financial Markets," Macroeconomics 0212007, EconWPA.
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  5. Leonardo Leiderman & Carmen Reinhart & Guillermo Calvo, 1992. "Capital Inflows and Real Exchange Rate Appreciation in Latin America: The Role of External Factors," IMF Working Papers 92/62, International Monetary Fund.
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  9. Guillermo A. Calvo & Leonardo Leiderman & Carmen M. Reinhart, 1996. "Inflows of Capital to Developing Countries in the 1990s," Journal of Economic Perspectives, American Economic Association, vol. 10(2), pages 123-139, Spring.
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  11. Peter Blair Henry, 2003. "Capital Account Liberalization, The Cost of Capital, and Economic Growth," NBER Working Papers 9488, National Bureau of Economic Research, Inc.
  12. Bekaert, Geert & Harvey, Campbell R. & Lundblad, Christian, 2005. "Does financial liberalization spur growth?," Journal of Financial Economics, Elsevier, vol. 77(1), pages 3-55, July.
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  14. Bonfiglioli, Alessandra, 2008. "Financial integration, productivity and capital accumulation," Journal of International Economics, Elsevier, vol. 76(2), pages 337-355, December.
  15. Patrick Honohan, 2004. "Financial development, growth, and poverty: how close are the links?," Policy Research Working Paper Series 3203, The World Bank.
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