Which Types of Capital Inflows Foster Developing‐Country Growth?

Abstract

As a result of the Asian crisis, both the virtues of domestic savings and the risks of foreign savings have been emphasized in the debate on development finance. In particular, East Asia, with its enviable saving rates, it has been argued by economists such as Joe Stiglitz and Jagdish Bhagwati, does not need foreign funds for investment and growth. This paper explores the benefits of private capital inflows by reviewing the analytical arguments advanced in the literature and by building fresh empirical evidence. Par‐ticular attention is given to the independent growth impact of the various broad categories of flows in the recipient emerging markets. The paper provides panel data analysis covering 44 countries over the period 1986–97; correcting for standard growth determinants, it measures the independent growth effect of foreign direct investment, portfolio equity investment, bond flows, as well as short‐term and long‐term bank lending. The findings suggest that developing countries should not solely rely on national savings, but rather should encourage foreign direct investment and portfolio equity inflows so as to stimulate long‐term growth prospects.