Dynamics of Investment and Growth in Developing Countries during the 1980s

Abstract

Since the outbreak of the debt crisis in 1982 growth and investment in developing countries have been persistently low by historical standards. Most of the adjustment processes undertaken during the 1980s included strong devaluations and fiscal adjustment relying heavily on lower public investment. The assessment of the consistency of these policies with expected increases in private investment and growth has been based up to now mainly on static cross-country models that show contradictory results, specially with regard to the role of foreign debt, the real exchange rate, and public investment. This paper discusses why static approaches are inappropriate for an essentially dynamic problem and proposes the estimation of a VAR-panel data model which may help clarify the relations between private investment and growth. The simulations of growth and investment responses to changes in the real exchange rate and the level of public investment show that dynamic responses through lagged effects differ substantially from what available static models suggest.