financial system a negative impact on investment in 30 Sub-Saharan
African countries between 1970 and 1995.- Greene and Villanueva (1991) find a positive impact on investment from
GDP growth, the level of per capita GDP, public sector investment, and a
negative impact from the real interest rate, domestic inflation, debt-service
ratio, and debt-to-GDP ratio on investment in developing countries
between 1975 and 1987. - King and Levine (1993) use an 80-country sample to find that between
1960 and 1989 financial development (size of liquid liabilities to GDP and
volume of private sector credit) is significantly related to subsequent
investment.
The statistical results offer no real guidance for policy. Barro’s finding that
human capital is related to growth offers no guidance to policy-makers on how
to increase human capital. Private or public education? Comprehensive or
selective education? Investing in primary or higher education? A centralized or
community based education system? Education in philosophy or engineering?
How should teachers be trained? Incentivized? Should schools get block grants
or pupils be given vouchers to spend in the school of their choice?
This literature fails to examine the deeper determinants of growth. A
policy such as subsidized credit is more likely to encourage investment in a
country with well-protected property rights, a favourable geography and in
which equipment can be readily imported from abroad. We see here an exam-
ple of an important theme of this book:that the study of proximate determi-
nants of economic growth is incomplete without any consideration of the
deeper determinants.
Thus policy is likely to have better chance to promote investment, and so
growth, in a developing country, but there are many cases where such efforts
have failed. Little policy guidance can be drawn from empirical studies. We
conclude that both market forces and government intervention can work to
promote investment and growth, but each will succeed only under specific
conditions.
Investment and the free market
It has been argued that the free market is the best way to promote efficient and
productive investment. In a free market sensible and forward-looking (called
by economists ‘rational’) individuals will make decisions about their savings.
The ‘life-cycle hypothesis’, for example, suggests that people save during their
mid-life high-earning years, but spend more than their income when young
and old. Savings will form of pool of resources in banks that are then available
for firms to borrow and invest. These firms are compelled by market competi-
tion to compete for the attention of profit-maximizing banks,by developing
the most alluring and profitable business plans. As well as mobilizing savings
and allocating resources to productive uses, freely operating financial markets
Domestic and Foreign Direct Investment 69