Public And Private Investment Nexus In Bangladesh: Crowding-In Or Out?

Abstract

To accelerate the GDP growth rate, the government of Bangladesh has been raising its public investment since late 2000s which is reflected in the rise of public investment-GDP ratio from 4.50% in 2008 to 6.90% in 2015. At the same time, private investment has remained stagnant since 2008, hovering around 22% of GDP. This trend of public and private investment suggests that public investment might have a crowding-out effect on private investment. Given this background, the main objective of this paper is to examine the relationship between public and private investment in Bangladesh over the period 1981-2015. To this end, we estimate a model in the autoregressive distributed lag bound testing framework using real private investment, real public investment, real GDP, and the real interest rate. In addition, since Bangladesh's trade and financial sectors went through intensive liberalization reform in the early 1990s, it warrants an investigation whether liberalization has any significant effect on the relationship between public and private investment. Hence, in this study, we pose an additional question of how the relationship between these two variables is affected by the liberalization of the financial and trade sectors - an issue received less attention in previous studies. To capture this effect, we extend our model by introducing a dummy variable for liberalization and an interaction term. Our results show that public investment negatively affects private investment both in the long run and short run, suggesting the existence of crowding-out. However, the crowding-out effect is partially neutralized by the favorable effect of liberalization. We also find that private investment is weakly sensitive to the real interest rate. These findings have important policy implications for both fiscal and monetary authorities. First, given the relatively large magnitude of crowding-out effect, it will be imperative for the fiscal authority to select those investment projects which have greater productivity and spillover effects so that crowding-out effect can be minimum. Second, the weak sensitivity of private investment to the interest rate points to a weak interest rate channel of monetary policy. Therefore, interest rate cut may not be successful in promoting private investment during economic down-turn. Third, as liberalization moderates the crowding out effect, Bangladesh can reap more benefit from public investment by removing the impediments to trade and financial deregulations.