Academic journal article Journal of Economic Development

Saving-Investment Nexus in Developing Countries: Does Financial Development Matter?

Academic journal article Journal of Economic Development

Saving-Investment Nexus in Developing Countries: Does Financial Development Matter?

Article excerpt

The Feldstein-Horioka puzzle is re-examined using a sample of 20 sub-Saharan Africa (SSA) countries. Unlike the extant literature we demonstrate the expediency of sustenance of financial sector reforms for the saving-investment nexus in SSA. Findings showed saving retention coefficients similar in magnitude to those already reported for developing countries, particularly SSA. In addition, however, the results uncovered a telling intervening role for financial deepening in the saving-investment space. Going forward, the precise nature and corresponding policy implications of this role should form an integral part of discussions in both academic and policy circles.

Keywords: Feldstein-Horioka Coefficient, Panel Mean Reversion, Fixed Effects, Sub Saharan Africa

JEL classification: C23, F21, F36, K11

(ProQuest: ... denotes formulae omitted.)

1. INTRODUCTION

A distinguishing feature of Africa's twenty first century epoch, especially in the wake of the recent global economic cum financial crisis, appears to be the declining trends in traditional sources of investments, especially Official Development Assistance (ODA), foreign direct investment (FDI) as well as remittances, emanating from the developed countries. This evolving investment regime could potentially persist as a result of a number of factors chief among which are binding budget constraints, macroeconomic imbalances and challenges in terms of reaching parliamentary consensus in these African investment supply hubs. The current global economic outlook thus situates Africa in a position of grappling with declining trade flows, a collapse of commodity prices, reduced access to international private financing, falling government revenues, reductions in remittances, and, to some degree, uncertainty about future commitments of official development assistance (Heintz and Ndikumana, 2010). There is no gainsaying the stymieing effects these turn of events could have on the growth trajectories of African economies.

The foregoing, both from policy and strategic perspectives, should prod the minds of policymakers within the African continent on intensifying efforts towards better domestic resource mobilization. This should be with a view to ensuring that the investment resources needed for growth can be partly offset from within, particularly amid unfavorable external conditions. Received economic wisdom offers a clear, arguable though, association between saving and investment on one hand and the growth promoting influence of investment on the other. Theoretically, in the absence of capital mobility, domestic investment financing should be largely saving-based, implying between these variables, a correlation metric in the neighbourhood of unity. Thus, under perfect capital mobility, savings should flow to the most attractive investment projects globally. The puzzle, however, was that Feldstein and Horioka (1980), FH hereafter, using data on 16 of the Organisation for Economic Cooperation and Development (OECD) countries over the 1960-1974 period reported the existence of rigidities and preferences which tend to keep saving locked in investments within the country of origin. This was clearly at variance with the intuition of near perfect capital mobility expected among the OECD economies, particularly in such an era characterized by ample push for global capital markets integration.

Also, in a parallel but relatively older literature, McKinnon (1973) and Shaw (1973) working independently identified a key role for financial intermediaries in matching funds from surplus to deficit units in the economy during the growth process. Thus, well functioning financial markets ought to minimize the divergence between domestic saving and available investment opportunities. Therefore, the higher the extent of financial sector advancement, the higher is the level of investment that can be financed via an efficient allocation of saving (Bencivega and Smith, 1991; Guiso et al. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.