The interaction effect of foreign capital inflows and financial development on economic welfare in sub-Saharan Africa

Kwame Acheampong

doi:10.1186/s40854-019-0139-z

Abstract

This study examines the interaction effects of foreign capital inflows and financial development on economic welfare in sub-Saharan Africa (SSA). Estimates based on the system-GMM estimator using panel data on 23 SSA countries for 2000 to 2013 establish several results. First, the interaction between foreign capital inflows and financial development positively affects economic welfare in SSA. However, this effect was negative after one year. Second, the partial indirect effects of foreign capital inflows on economic welfare, conditional on the level of financial development, are positive, though they become negative after one year. Third, the total effect of foreign capital inflows on economic welfare is positive. The effect becomes negative after a year, though the predominant source of financial development is domestic credit. The consistency of these results indicates the importance of financial development in transmitting foreign capital to economic welfare enhancement. Developing the SSA’s financial sector to meet specific welfare-enhancing demands may potentially convert a large share of capital inflows into improved economic welfare and eliminate the negative effects.

Highlights

Greenwood and Jovanovic (1990) suggest that financial development directly affects economic welfare over time
FDi, t is the financial development (FD) indicator as a ratio of Gross domestic product (GDP), and FCFi, t ∗ FDi, t is the interaction term to establish whether foreign capital inflows (FCF) affect economic welfare as it interacts with FD
I investigate the role of FD in improving this direct welfare-enhancing index in the presence of FCF in sub-Saharan Africa (SSA)

Summary

Introduction

Greenwood and Jovanovic (1990) suggest that financial development directly affects economic welfare over time. In view of the general support for expenditures on education, health, household consumption, and remittances as a monetary measure of investment in economic welfare (Appendix 4), I first examine the effect of the interaction of FD and FCF on these individual variables. The model expresses human economic welfare as an index constructed using PCA and comprising government expenditure on education and healthcare, household consumption expenditures, and remittances as a function of FCF (a vector of official credit and foreign direct investment, FDI), the FD indicator, and the interaction between the two independent variables. FDi, t is the FD indicator (domestic credit to the private sector; money supply) as a ratio of GDP, and FCFi, t ∗ FDi, t is the interaction term to establish whether FCF affect economic welfare as it interacts with FD. Due to the prevalence of “true zeros” in the portfolio equity and private credit data, I use FDI and official credit as proxies of FCF for the analysis (Tables 2, 3 and 4)

Findings

Discussion

Conclusion