APPENDIX: Definitions and Data Sources
The basic source for the data used in this study is International Financial Statistics (IFS), International Monetary Fund (Washington), various issues. This source was augmented, when necessary, by Fund staff estimates. Gross private and public investment data are based essentially on national sources. The data were all deflated by the GDP deflator (1975 = 1.00) to express them in real terms. For current values of the variables, the period covered was 1971–79; lagged values of the variables, therefore, were defined over the period 1970–78.
The 24 developing countries in the sample were Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, Guatemala, Haiti, Honduras, Mexico, Panama, Paraguay, Venezuela, Barbados, Trinidad and Tobago, Turkey, Singapore, the Republic of Korea, Sri Lanka, Malaysia, Indonesia, and Thailand.
The definitions of the variables (with the IFS line numbers, where relevant) are as follows:
IP = gross private fixed capital formation (in real terms)
GIR = gross public sector fixed capital formation (in real terms; for most countries the public sector is defined to include general government, principal autonomous agencies, and nonfinancial state enterprises)
YR = GDP in constant 1975 prices (line 99b. p)
- TYR = trend value of real GDP, calculated as
where YR1970 is the 1970 value of real GDP, and g1 is its trend growth rate over the period 1970–79
- GAP = deviation of real GDP from its trend value; that is,
ΔDCR = change in credit to the private sector (line 32d) in real terms, plus real net private capital inflows (taken from Balance of Payments Statistics Yearbook, International Monetary Fund (Washington), Vol. 33, Parts I and II (1982))
- TGIR = trend value of real gross public sector investment, calculated as
where GIR1970 is the 1970 value of real public sector investment, and g2 is the average growth rate of GIR over the period 1970–79
- EGIR = expected real gross public sector investment, calculated as
where ρ0 and ρ1 are autoregressive parameters estimated for each country over the period 1970–79.
The dummy variables for the 24 countries, which took a value of unity for the nine observations corresponding to a particular country and a value of zero elsewhere, were entered into the equations in the order in which the countries are listed above.
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Mr. Khan, Advisor in the Research Department, is a graduate of Columbia University and of the London School of Economics and Political Science.
Mr. Blejer, Assistant to the Director of the Fiscal Affairs Department, is a graduate of the Hebrew University of Jerusalem and of the University of Chicago. He has been on the faculties of the Hebrew University, Boston University, and New York University.
An earlier version of this paper was presented at the Fourth Latin American Congress of the Econometric Society, Santiago, Chile, July 19–22, 1983. The authors are grateful to Edward Buffie, Sebastian Edwards, George von Furstenberg, and Roberto Zahler for helpful comments and advice.
For a general discussion of the effects of government expenditures on capital formation, see von Furstenberg and Malkiel (1977). Both the studies by Sundararajan and Thakur (1980) and by Tun Wai and Wong (1982) also stress the independent effects of government investment on private investment.
The countries in the sample are Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, Guatemala, Haiti, Honduras, Mexico, Panama, Paraguay, Venezuela, Barbados, Trinidad and Tobago, Turkey, Singapore, the Republic of Korea, Sri Lanka, Malaysia, Indonesia, and Thailand. For information on data sources, see the Appendix.
The study by Sundararajan and Thakur (1980) comes closest to directly applying the neoclassical model to two developing countries—India and the Republic of Korea.
Strictly speaking, because we are considering private sector investment, the output variable should be the expected private sector output. For simplicity we assume that private sector output is proportional to total output and therefore work with total output throughout. An alternative approach, which would not change the analysis in any significant manner, would be to treat YRe as future aggregate demand.
See Klein (1974). Using an alternative production function—for example, a Cobb-Douglas function—would directly introduce the ratio of the rental price of capital to wages, or the ratio of the price of investment goods to the price of capital services, into equation (1). As we mentioned above, none of such variables can easily be calculated for developing countries. For this reason we have had to assume a somewhat restrictive model that does not admit the possibility of factor substitution.
Dynamics can also be introduced by specifying a distributed-lag function for expected output; see Hall (1977).
This equation requires that
The latter method, discussed later, turns out to yield an estimation equation that is similar to the one obtained by the method adopted here.
See von Furstenberg (1980). As noted in that paper, the cyclical response may itself involve lags arising from the difficulties in terminating ongoing investment projects as demand declines and in initiating investment rapidly as demand picks up.
The situation is further complicated if expectations are introduced into the analysis. For example, if output is abnormally high, it may be expected to grow at rates below average in the future stages of the cycle, and thus current investment may decline.
This view, associated with McKinnon (1973), has gained considerable currency in the literature on financial development.
This may be somewhat restrictive for those developing countries in which firms can issue shares and obtain equity financing. In most developing countries, however, this form of financing is only a limited possibility.
For a discussion of the effects of interest rates on investment, see Galbis (1979), and Fry (1980, 1982). It is interesting to note that, in the currently popular models of financial development, an increase in interest rates, by increasing financial savings, raises rather than lowers private investment.
A theoretical discussion of how an increase in foreign capital flows can increase total financial savings is contained in Khan and Knight (1982).
Other tools of monetary policy, such as open-market operations, have a limited scope in economies where capital and bond markets remain relatively underdeveloped.
See von Furstenberg and Malkiel (1977). There does not, however, seem to be much empirical support for the proposition discussed by David and Scadding (1974)—that the private sector perceives any addition to the government capital stock as potentially competing with its own and, therefore, that any increase in public sector investment is matched by an immediate and equal decline in the desired rate of private investment.
Note that we have explicitly assumed that causation runs from public sector investment to private investment. It can be argued that causation also runs the other way if the government has a reaction function that allows public investment to respond to economic variables, including private investment. See Heller (1975).
The trend level of output (TYR) is calculated as TYR = YR0eg1t, where YR0 is the initial value of output, g1 is the average growth rate of YR, and t is a linear time trend.
For example, Sundararajan and Thakur (1980) found the coefficient of the public sector capital stock in the private investment equation to be statistically insignificant in both countries (India and the Republic of Korea) of their sample. Furthermore, the coefficient corresponding to b3 was significantly different from zero at the 5 percent level in only one country (Greece) of the five studied by Tun Wai and Wong (1982). Similar insignificant results are also reported by Galbis (1979).
The trend level of real public sector investment is calculated as TGIR = GIR0eg2t, where GIR0 is the initial value of real public sector investment, g2 is the average growth rate of GIR, and t is a linear time trend.
To the extent that public infrastructural investments are “lumpy” and there are replacement cycles following periods of high public investment, this type of trend approximation might be in error. For this reason, and others, we use different measurements for public infrastructural investment.
It could also be argued in a rational expectations framework that, if there is a high degree of substitutability, the effect of expected public investment on the rate of private investment would be negative. Correspondingly, since private investors could not respond quickly to surprises, this negative effect may turn out to be insignificant. Ultimately, the issue is an empirical one.
This process was chosen arbitrarily, and no attempt was made to test for alternative, more complicated autoregressive schemes. With annual data and a limited number of observations for each country, the simple process given by equation (18) seemed to be appropriate.
This yielded 216 observations for each of the variables. The basic data are described in the Appendix.
Preliminary tests with an error-components model yielded similar results, so that for the sake of simplicity we stayed with the least-squares-with-dummy-variables procedure. From a computational point of view, using the latter has a decided advantage in models employing the adaptive expectations scheme, which, as has been shown in the previous section, introduces nonlinearities into the system.
In other words, the lagged change in real GDP is defined as ΔYRt−1 = YRt−1 − 0.95YRt−2. This 5 percent value is close to the estimates obtained by Sundararajan and Thakur (1980). Some sensitivity analysis was performed by varying δ, but the results remained broadly the same as those discussed here in the paper.
The negative sign for the nontrend public investment could also reflect countercyclical public investment policy rather than crowding out per se.
The one drawback associated with Beta coefficients is that their statistical distribution is not known. As such, one cannot perform formal tests of significance, and any inferences necessarily have to be casual.