Capital Mobility, Foreign Aid, and Openness: Further Panel Data Evidence from Sub-Saharan Africa

By Payne, James E.; Kumazawa, Risa | Journal of Economics and Finance, Spring 2005 | Go to article overview

Capital Mobility, Foreign Aid, and Openness: Further Panel Data Evidence from Sub-Saharan Africa


Payne, James E., Kumazawa, Risa, Journal of Economics and Finance


Abstract

This study uses several alternative panel data estimation techniques (pooled ordinary least squares, fixed effects, and random effects) to examine the effect of domestic savings, foreign aid, the evolution of capital mobility over time, and openness on investment rates for a sample of 29 sub-Saharan African countries over the time period 1980 to 2001. The empirical evidence suggests the presence of capital mobility in line with previous studies of developing economies and that capital mobility has gradually increased over time. Moreover, foreign aid and openness both have positive and significant impacts on investment rates. (JEL F21, F30, F32, F35)

Introduction

Though some of the countries of sub-Saharan Africa have shown improved economic performance since the early to mid-1990s, the region's relatively weak economic growth has contributed to a relatively low savings rate and capital flight from the region. [See Collier and Gunning (1999).] Understanding the extent to which domestic savings finance domestic investment has important implications for policymakers in the formulation of tax policy and its effect on domestic savings behavior. Moreover, with respect to developing economies, the examination of foreign aid as a factor in financing domestic investment is vital in the assessment of the effectiveness of foreign aid programs. The task of this note is to examine the effect of domestic savings, foreign aid, the evolution of capital mobility over time, and the degree of openness on investment rates for a panel data set of 29 sub-Saharan Africa countries. To assess the robustness of the empirical results, three alternative panel data estimation techniques-pooled ordinary least squares (POLS), fixed effects (FE), and random effects (RE) models-are used in the analysis. The next section presents the methodology, data, and results along with concluding remarks.

Methodology, Data, and Results

The Feldstein-Horioka (1980) investment-savings equation is given as in (1) where (I/Y)^sub it^ and (S/Y)^sub it^ represent the investment and saving rates, respectively, for country i at time t.

Feldstein and Horioka estimate a high savings-investment correlation for a sample of OECD countries. According to Feldstein and Horioka, a high savings-investment correlation reflects capital immobility, whereas a lower correlation represents capital mobility. In light of the fact that the integration of global capital markets has increased over time, the Feldstein-Horioka interpretation of limited capital mobility has been viewed with skepticism.'

In the case of developing economies, Dooley et al. (1987), Wong (1990), Mamingi (1997), Vamvakidis and Wacziarg (1998), Coakley et al. (1999), lsakasson (2001), and Sinha and Sinha (2004) find that the coefficient on savings in equation (1) is low or insignificantly different from zero (i.e., evidence of capital mobility). Moreover, the savings coefficients for developing economies are generally smaller than those found for industrialized economies. This result seems counterintuitive given the belief that industrialized economies have more integrated capital markets as well as less restrictive regulatory environments than developing economies. However, a number of reasons have been set forth to explain the relatively low savings-investment correlation for developing economies." We extend the analysis by Isaksson (2001) beyond the inclusion of foreign aid and the evolution of capital mobility over time to include also the impact of openness.

The augmented version of the Feldstein-Horioka specification is given as follows in (2).

The variables are defined as follows and were obtained from the World Bank Indicators CD-ROM for 29 sub-Saharan African countries over the period 1980 to 2001/ [Sec appendix for list of countries.]

Gross fixed capital formation per GDP (I/Y)

Gross domestic savings per GDP (S/Y)

Foreign aid per GDP (FA/Y)

Sum of exports and imports per GDP ((EX + 1M)/Y]

Interactive time trend with savings (T *(S/Y))

A priori, it is hypothesized that the coefficient on the savings rate should be positive. …

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