TO STIMULATE INVESTMENT WHAT INSTITUTIONS AND POLICIES SHOULD BE ADOPTED?
TRADE-OFFS BETWEEN PRIVATE AND PUBLIC INVESTMENT

Jeffrey B. NUGENT (University of Southern California)

In recent years there has been considerable interest in relating numerous factors from outside basic economic fundamentals to investment and economic growth. Among these are social and political instability (SPI), property rights, democracy, corporate tax rates, exchange rate distortions, rationing of scarce resources, corruption and other features of political economy. Since most of these factors differ more across countries than over time, most of these studies have been based on international cross section analysis. Some striking paradoxes have arisen in some of this research. For example, investment has been much less responsive to some of these determinants than might have been expected; or even responded in perverse ways.

The purpose of this paper is to show that some of these paradoxes can be explained by the fact that these influences may be quite different - even of opposite direction - on public and private investment expenditures. Whereas the theory of investment spending is generally focused on private investment, in fact because of the shortage of data distinguishing between private and public investment, most empirical studies use data on aggregate investment (gross fixed capital formation). In some cases, the effects on aggregate investment may be dominated by the effect of private investment as in most rich countries. Yet in most developing countries that often contribute the most observations to international cross-section studies, public investment is also very important.

This paper investigates the behavior of private and public spending separately in a reasonably large unbalanced panel data set of 45 countries over the period 1970-1998. The results identify several important policy and institutional variables that have very different effects on private investment than on public investment, thereby potentially contributing to the explanation of some of the aforementioned paradoxes.