Private capital flows and economic growth in Africa: The role of domestic financial markets

Int. Fin. Markets, Inst. and Money 30 (2014) 137–152

Contents lists available at ScienceDirect

Journal of International Financial Markets, Institutions & Money j o ur na l ho me pa ge : w w w . e l s e v i e r . c o m / l o c a t e / i n t f i n

Private capital flows and economic growth in Africa: The role of domestic financial markets Elikplimi Komla Agbloyor a,∗, Joshua Yindenaba Abor a,1, Charles Komla Delali Adjasi b,2, Alfred Yawson c,3 a b c

Department of Finance, University of Ghana Business School, PO Box LG 78, Legon, Ghana University of Stellenbosch Business School, PO Box 610, Bellville 7535, South Africa University of Adelaide Business School, 10 Pulteney Street, Adelaide, SA 5005, Australia

a r t i c l e

i n f o

Article history: Received 22 October 2012 Accepted 12 February 2014 Available online 19 February 2014 JEL classification: E44 F21 O16 Keywords: Africa Capital flows Economic activity Financial markets

a b s t r a c t This study examines the relation between private capital flows and economic growth in Africa during the period 1990–2007. We estimate the empirical relation with a panel Instrumental Variable Generalized Method of Moments (IV-GMM) estimator which allows for arbitrary heteroskedasticity and endogeneity. Decomposing private capital flows into its component parts, we find that foreign direct investment, foreign equity portfolio investment and private debt flows all have a negative impact on economic growth. Countries with strong domestic financial markets, however, benefit more by being able to transform the negative impact of private capital flows into a positive one. Private capital flows, thus, promote economic growth in the presence of strong domestic financial markets. These results suggest that strong financial markets are needed for private capital flows to impact economic growth positively. Our results are robust to the control of population size, savings, financial openness and institutional quality. © 2014 Elsevier B.V. All rights reserved.

∗ Corresponding author. Tel.: +233 244973939; fax: +233 0302 500024. E-mail addresses: [email protected] (E.K. Agbloyor), [email protected] (C.K.D. Adjasi), [email protected] (A. Yawson). 1 Tel.: +233 0302 501594x117; fax: +233 0302 500024. 2 Tel.: +27 021 918 4284; fax: +27 021 918 4468. 3 Tel.: +61 8 8313 0687; fax +61 8 8223 4782. http://dx.doi.org/10.1016/j.intfin.2014.02.003 1042-4431/© 2014 Elsevier B.V. All rights reserved.

138

E.K. Agbloyor et al. / Int. Fin. Markets, Inst. and Money 30 (2014) 137–152

1. Introduction Most African countries experienced anaemic growth after independence in the 1970s through to the early 1990s. Easterly and Levine (1997) described Africa as a growth tragedy. It must be noted, however, that the growth dynamics in Africa have changed since the early 1990s. Many of the world’s fastest growing economies are now in Africa and most African countries are growing faster than countries in the developed world and are experiencing growth rates higher than the world average. With a world economic growth rate of around 4%, the International Monetary Fund (IMF) forecasts that sub-Saharan Africa’s GDP will grow by 5.25% in 2011 and 5.75% in 2012 (IMF, 2011). All major capital flows to Africa have increased considerably since 1980, especially FDI, which increased eightfold over the period 1980–2003 (UNECA, 2006). Although private capital flows on the whole have risen sharply, there are important variations in the growth of its various components. For example, the growth in FDI has outpaced the growth in Foreign Portfolio Investment (FPI) and debt flows with each component having a potentially differing impact on economic activities in Africa.4 Consequently, in this paper we examine how the various components of private capital flows help resolve the African growth tragedy lamented by Easterly and Levine (1997). Focusing the study on Africa is particularly significant because private capital flows are widely considered by African policy makers and developmental partners as important investment vehicles through which the African growth problem can be addressed. A study that systematically evaluates the impact of private capital flow on growth is thus warranted. This study fills this gap and goes a step further to explore the conditions required for private capital flows to have the expected impact on growth. Using capital flows data from 14 African countries over the period 1990–2007, our initial results indicate that private capital flows have a detrimental effect on economic growth. In theory, financial sector development has the potential to affect the allocation of savings and thus improves economic growth (Schumpeter, 1912). Consistent with this view, Alfaro et al. (2004) provide evidence that strong financial markets are necessary institutions that a country must have for FDIs to have a positive influence on economic growth. They document that countries with good domestic financial markets benefit more from FDI inflows. Further, Brambila-Macias and Massa (2010) examine if slowing capital flows due to the recent global financial crises is likely to reduce economic growth in Africa. They find that FDI and cross border bank lending exert a positive and significant impact on economic growth. Similarly, Choong et al. (2010) show financial markets matter in the link between capital flows and economic growth. Recently, Kendall (2012) provides evidence that banking sector development is a necessary condition for economic growth at the district level. Consequently, we extend our initial analysis to examine whether the presence of good financial markets is necessary for private capital flows to have the desired positive effect on economic growth. Our approach is innovative and different from Alfaro et al. (2004), Brambila-Macias and Massa (2010), Choong et al. (2010) and Kendall (2012) in the sense that we consider other capital flows apart from FDI. Further, we interact private capital flows with proxies for both stock market and banking sector development, and we consider the joint endogeneity of private capital flows and financial development with economic growth. We also test our hypothesis using African data which has been neglected in this area of investigations. We find that, indeed, having a well developed financial market is a necessary condition to transform the negative effect of private capital flows into a positive. The results suggest that in the absence of a well developed financial market, private capital flows are unlikely to improve economic growth. We obtain stronger results when we interact FDI with financial markets compared to the interaction with the other components of private capital flows. This likely point to the more desirous nature of FDI

4 Foreign Portfolio investments can be divided into equity foreign portfolio investments (EFPI), debt foreign portfolio investments and flows in financial derivatives. There are various forms of external debt. Total external debt is divided into short-term and long-term debt. Long-term debt is also made up of private non-guaranteed external debt and public and publicly guaranteed external debt. Private capital flows have surged recently to developing countries across the world. Net private capital flows to developing nations increased more than six-fold to reach US$230 billion per year during 1995–1997 from around US$36 billion per year during 1987–1989 (World Bank, 1998). Net private capital flows to developing countries again increased from about $110 billion in 2008 to about $386 billion in 2009 (United Nations, 2011).

E.K. Agbloyor et al. / Int. Fin. Markets, Inst. and Money 30 (2014) 137–152

139

flows. However, our results suggest that countries with strong financial markets can also benefit even from EFPI and debt flows. Thus, our results are consistent with the Schumpeterian view on financial markets development and economic growth. The rest of the paper is structured as follows: Section 2 examines the extant literature on capital flows and economic growth, Section 3 details the methodology employed in the empirical analysis, in Section 4 we present the results from the empirical estimations and finally in Section 5 we conclude the paper. 2. Theoretical background The popular theories that explain economic growth include the Schumpeter theory on economic growth, the Solow–Swan (neo-classical) growth theory and endogenous growth theories. According to the Schumpeterian view, finance affects the allocation of savings and improves productivity growth and technological change (Beck et al., 2000). In this framework, financial markets allocate savings (which may be partly from foreign capital flows) and finance innovations which may be due to new technology introduced by foreign firms. Therefore foreign capital flows improve capital accumulation and technological diffusion thus promoting economic growth. Financial markets improve the liquidity and tradability of assets in an economy, provide opportunities for economic agents to diversify risk, reduce information asymmetry by collecting information on deficit units, promote savings mobilization and the attraction of foreign capital and improve the corporate governance of firms. Thus by performing these functions financial intermediaries aid the process of economic growth. Previous studies provide empirical support to theoretical predictions that finance should exert a positive influence on economic growth (King and Levine, 1993; Beck et al., 2000; Allen and Ndikuma, 2000; Adjasi and Biekpe, 2006; Romero-Avila, 2007; Manu et al., 2011; Kendall, 2012). The channels through which finance is likely to affect growth are through the improvement in savings, physical capital accumulation and total factor productivity growth. In his classic 1956 article Solow proposed that we begin the study of economic growth by assuming a standard neoclassical production function with decreasing returns to capital (Mankiw et al., 1992). The neo-classical theory predicts that countries with higher savings and lower population growth rates will grow at a faster pace (see Mankiw et al., 1992). This theory highlights the importance of technological progression in the process of economic growth. It postulates that economic growth will cease without advances in technology. The Solow growth model assumes that poorer countries should exhibit higher rates of return on both physical and human capital. It also predicts convergence in per capita income across countries whereby poorer countries grow faster and catch up with richer countries. According to the neo-classical theory, apart from labour and capital, other factors account for the differences in growth across countries. These factors are captured by the residual term or what is termed as total factor productivity. Therefore growth is determined outside the system. The augmented Solow model adds factors of production such as human capital that do not exhibit constant returns to scale. An augmented Solow model includes accumulation of human as well as physical capital (Mankiw et al., 1992). Therefore in this framework, foreign capital should affect the savings rate which in turn affects economic growth. Also, in the case of FDI for example, introduction of new technologies will ensure that growth continues. Beginning in the 1980s economists became increasingly dissatisfied with the neo-classical theory because it had a poor fit when confronted with cross-country data and because in this model growth was determined outside of the model. These economists therefore sought to build a model that internalized the growth process. They therefore propounded a model where growth was endogenous to the system. The endogenous growth theory builds on the Solow approach and adds more sets of explanatory variables to the neo classical growth theories. In endogenous growth theories, crucial importance is usually given to the production of new technologies and human capital. Human capital in the endogenous growth model is believed to exhibit increasing returns to scale. Unlike the Solow growth model, endogenous growth theories do not predict convergence. In a simple endogenous growth model, capital flows can promote growth by increasing the domestic investment rate, by leading to investments that are associated with positive spillovers, and/or by increasing domestic financial intermediation (Bailliu, 2000). Further, even if two countries receive an equal amount of

140

E.K. Agbloyor et al. / Int. Fin. Markets, Inst. and Money 30 (2014) 137–152

net capital inflows, this model predicts that the country with the more developed financial system will have a higher growth rate, because its financial sector is more efficient at converting the foreign funds into productive investments, and better able to allocate them to the most productive investment projects. Prior studies report positive effects of capital flows, namely FDI and FPI on macroeconomic indicators (Borensztein et al., 1998; Bekaert and Harvey, 1998, 2000; in Durham, 2004). However, some economists argue that capital flows have no growth impact and that they may even be deleterious to growth. Others argue that the growth impact of capital flows especially FDI depend on host country conditions such as initial GDP (Blomstrom et al., 1992), trade openness (Balasubramanyam et al., 1996), human capital (Borensztein et al., 1998), macroeconomic stability (World Bank, 2001), infrastructure (World Bank, 2001) and financial development (Hermes and Lensink, 2003; Omran and Bolbol, 2003; Alfaro et al., 2004; Durham, 2004). Using panel data for 40 developing countries from 1975 to 1995, Bailliu (2000) finds evidence that capital inflows foster economic growth, above and beyond any effects on the investment rate, but only for economies where the banking sector has reached a certain level of development. Soto (2000) finds that FDI and EFPI flows exhibit a positive, significant and robust correlation with income growth in developing countries whereas short and long-term bank related inflows show significant negative correlation with growth. However, the negative relation holds only when domestic banks have low capitalisation ratios. Durham (2004) finds that the positive effect of FPI on growth is contingent on financial development and legal variables or comparative institutions. In particular, they find that FPI inhibits growth in countries with comparatively small equity markets and pervasive corruption. Choong et al. (2010) investigate how FDI, portfolio investments and foreign debt flows promote economic growth in developed and developing countries through the channel of domestic stock markets. They find that portfolio investment and foreign debt have a negative effect on growth whilst FDI has a significantly positive effect. Even though portfolio investment and foreign debt have negative effects on economic growth, the coefficients of the interaction terms are positive and significant implying that the development of the stock market benefits the recipient country. Regarding the negative relation observed between debt flows and economic growth, Alfaro et al. (2004) suggest that the apparent ‘puzzle’ in the literature may be no puzzle at all. They explain that the data fits the neoclassical prediction better than previously thought and that the puzzling results emanate from the fact that the capital flows data include financing from other sovereigns and aid data. They therefore conclude that sovereigns and official donors invest in low return countries, most likely for political considerations. Broadly, the literature suggests that the positive impact of capital flows on growth may crucially depend on the level of development of financial markets in the host country. Our simple conceptualization of the process through which foreign capital influences economic growth as well as how financial markets interact with foreign capital flows to spur economic growth is depicted in Fig. A.1. Foreign capital flows add to domestic investment in the host country. They also affect savings in the host country. Financial markets transform society’s savings into investment. These savings can be domestic savings or savings induced from foreign capital flows in an open economy with capital flows. These investments through foreign capital then increase human capital and technological innovation thus increasing the level of productivity in the host economy. The increased level of productivity generates increases in economic growth which in turn reinforces further inflows of foreign capital. Strong financial markets are needed to positively intermediate private capital flows to spur economic growth. We test this hypothesis using African data. 3. Data and empirical models We utilize data on 14 African countries covering the period 1990–2007.5 We obtain all the data apart from the financial openness measure, the institutional quality measure and the bank credit

5 The countries used in the empirical analysis are Botswana, Cote D’Ivoire, Egypt, Kenya, Malawi, Mauritius, Morocco, Namibia, South Africa, Swaziland, Tanzania, Tunisia, Uganda and Zambia.

E.K. Agbloyor et al. / Int. Fin. Markets, Inst. and Money 30 (2014) 137–152

141

Fig. A.1. Foreign capital flows, financial markets and economic growth.

ratio from the African Development Indicators online database published by the World Bank. Our empirical model is similar to Durham (2004). We utilize a panel Instrumental Variable Generalized Method of Moments (IV-GMM) estimation allowing for arbitrary heteroskedasticity. The IV approach also enables to overcome the potential endogeneity of the finance and capital flows variables. The instrumental variable (IV) Two Stage Least Square estimation (2SLS) can be viewed as a GMM problem. If the errors satisfy all classical assumptions and the optimal weighting matrix is proportional to the identity matrix, the IV-GMM estimator is merely the standard IV (2SLS) estimator (Baum, 2009). In general, in the case of an over-identified equation, the IV-GMM estimator can produce different point estimates and smaller standard errors as the IV-GMM estimator is more efficient compared to the IV/2SLS robust estimator (Buam, 2009). We specify our model as follows; yit = ˇ1 Capflowsit + ˇ2 Financeit +

N j=1

ˇJ Xit + εit

where yit is real GDP in constant 2000 USD for country i in time t; εit = vi + it ; that is the composite error term; Capflowsit is FDI, EFPI, private non-guaranteed debt flows and total capital flows for country i at time t. FDI is net inflows of investment to acquire a lasting interest in or management control over an enterprise operating in an economy other than that of the investor. It is the sum of equity capital, reinvested earnings, other long-term capital, and short-term capital, as shown in the balance of payments. FDI is measured as FDI divided by GDP. EFPI includes net inflows from equity securities other than those recorded as direct investment (FDI) and including shares, stocks, depository receipts (American or global), and direct purchases of shares in local stock markets by foreign investors. EFPI is measured as EFPI divided by GDP. Debt is private non-guaranteed net flows on external debt and is defined as an external obligation of a private debtor that is not guaranteed for repayment by a public entity. Net flows (or net lending or net disbursements) received by the borrower during the year are disbursements minus principal repayments. Long-term external debt is defined as debt that has an original or extended maturity of more than one year and that is owed to non-residents by residents of an economy and repayable in foreign currency, goods, or services. Total private capital flow is the summation of FDI, EFPI and private non-guaranteed debt. We divide the capital flows variables by GDP to normalize them and to preserve the negative figures.

142

E.K. Agbloyor et al. / Int. Fin. Markets, Inst. and Money 30 (2014) 137–152

We hypothesize a positive and significant relation between FDI and economic growth whilst EFPI is expected to have a negative impact. A negative effect is plausible as EFPI can be quite volatile as foreign investors can easily withdraw their funds from domestic stock markets which may adversely affect the stock market. Poor stock market performance can in turn lead to low growth outcomes. A positive effect is plausible because EFPI can contribute to domestic stock market development and can therefore lead to economic growth. Based on evidence from Alfaro et al. (2004) we hypothesize a positive link between private non-guaranteed debt and economic growth. Financeit represents indicators for financial market development for country i at time t. The financial markets variables used in the empirical estimations are the stock market capitalization ratio, stock market turnover, bank credit to GDP ratio, private credit to GDP ratio and the M2 to GDP ratio. Market capitalization is the share price times the number of shares outstanding. The market capitalization ratio is defined as market capitalization divided by GDP. Turnover ratio is the total value of shares traded during the period divided by the average market capitalization for the period. Average market capitalization is calculated as the average of the end-of-period values for the current period and the previous period. The bank credit ratio is domestic credit provided by the banking sector and includes all credit to various sectors on a gross basis, with the exception of credit to the central government, which is net. The banking sector includes monetary authorities and deposit money banks, as well as other banking institutions. Private credit refers to financial resources provided to the private sector, such as through loans, purchases of non-equity securities, and trade credits and other accounts receivable, that establish a claim for repayment. M2 is money and quasi money and comprise the sum of currency outside banks, demand deposits other than those of the central government, and the time, savings, and foreign currency deposits of resident sectors other than the central government. M2 is measured as M2 divided by GDP. Based on theoretical predictions, we hypothesize a positive relation between financial development indicators and economic growth. Xit is a vector of information conditioning set for country i in time t. These determinants follow from the growth literature and include population, savings, financial openness and institutional quality and are included as control variables. These variables are assumed to be exogenous to the process of economic growth. We measure population as the log of population. Countries with larger populations can achieve higher productivity and have the market base to drive economic growth. We therefore hypothesize a positive relation between population size and economic activity. Gross domestic savings is GDP less final consumption expenditure. Savings is measured as gross domestic savings divided by GDP. Traditional growth theories postulate that savings matter for economic growth. Choong et al. (2010) find that savings have a positive and significant effect on growth in both developed and developing countries. We therefore hypothesize a positive relation between savings and economic activity. We use Chinn and Ito’s (2008) measure of capital account openness as our indicator of financial openness. The index is a de jure measure of financial openness with higher values indicating more financial openness. The index ranges from −1.83 to +2.5. We hypothesize a positive relation between financial openness and economic activity since financial openness makes it possible for an economy to receive foreign capital flows. The civil liberties index from Freedom House is used as an indicator of institutional quality. Civil liberties allow for the freedoms of expression and belief, associational and organizational rights, rule of law, and personal autonomy without interference from the state. The index ranges from 1 to 7 with lower values indicating more civil liberties. Endogenous growth theorists emphasize that institutional and governance indicators matter for growth (see Acemoglu et al., 2004). Alfaro et al. (2004) find that good quality institutions matter for economic growth. Countries with better and stronger institutions should experience higher levels of economic growth. Since we utilize the civil liberties index where lower values represent higher institutional quality, we hypothesize a negative relation between the civil liberties index and economic activity. It is theoretically possible that the capital flows and financial market variables increase with the increases in the growth rate. We use an instrumental variable set for the capital flows and financial market indicators. We employ instruments for these variables because they may be endogenously determined with economic growth. The instruments used for the capital flows variables are one lag of the capital flows variable, exchange rate with the US$ and exchange rate volatility. The instruments

E.K. Agbloyor et al. / Int. Fin. Markets, Inst. and Money 30 (2014) 137–152

143

Table A.1 Descriptive summary statistics. Variable

Obs

Mean

Std. dev.

Min

Max

FDI EFPI Debt Market capitalization Stock market turnover Bank credit Private credit M2 Population Savings Financial openness Institutions

234 252 230 209 146 248 248 249 252 250 248 252

0.024 0.003 0.001 0.313 11.966 0.464 0.355 0.388 16.123 0.160 −0.237 3.956

0.030 0.011 0.009 0.491 17.311 0.461 0.322 0.239 1.381 0.114 1.390 1.325

−0.075 −0.024 −0.024 0.010 0.000 −0.730 0.030 0.060 13.670 −0.050 −1.831 1.000

0.213 0.088 0.081 2.940 126.000 1.980 1.640 1.010 18.198 0.560 2.500 7.000

The table reports the descriptive statistics. FDI is foreign investment that reflects 10% or more of voting equity and is divided by GDP; EFPI is foreign investment in equity securities divided by GDP; debt represents external debt accruing to the private sector divided by GDP; the market capitalization ratio is the stock market capitalization divided by GDP; stock market turnover is the stock market value traded divided by market capitalization; bank credit is domestic credit to the private sector provided by banks divided by GDP; private credit is domestic credit to the private sector by banks and other financial institutions divided by GDP; M2 is liquid liabilities of the financial sector divided by GDP; population is the log of population size; savings is gross domestic savings divided by GDP; financial openness is Chinn and Ito’s (2008) measure of capital account openness; institutional quality is the civil liberties index and is obtained from Freedom House.

for the financial market variables include one lag of the financial market variable being estimated. In the case of the stock market indicators, we augment the lag of the financial market variable with the number of listed firms. For the banking indicators, we augment the lag of the financial market variable with the deposit rate. All instruments are employed at once making five instruments for each estimation. We use one lag of FDI following evidence by Wheeler and Mody (1992) that FDI flows are reinforcing. Also past EFPI and debt flows influence current levels of EFPI and debt flows. Froot and Stein (1991) show that an appreciating home currency can increase the FDI decision of home firms. According to Alfaro et al. (2004) among the few consistently significant determinants of FDI are real exchange rates and lagged FDI. We therefore follow Alfaro et al. (2004) and use the exchange rate as an instrument for the capital flows variables. Further, we use exchange rate volatility as an additional instrument for the capital flows variables since they are likely to affect the levels of foreign capital flows. Exchange rate volatility is computed as the annual standard deviation of the monthly exchange rate variable over the period 1990–2007. Listed companies affect stock market capitalization and turnover and their effect on economic growth is likely to be through their effect on the stock market indicators. The deposit rates also affect the banking indicators but are not directly linked to economic growth and should therefore serve as valid instruments. Due to the fact that capital flows may not have an independent impact on economic growth, we also estimate a second equation to capture the interactive effect between capital flows and financial markets. The model closely follows that employed by Durham (2004) and it is specified as follows; yit = ˇ1 Capflowsit + ˇ2 Financeit + ˇ3 (Capflowsit × Financeit ) +

N j=4

ˇj Xit + it

where ˇ3 represents the interactive effect between the capital flows variables and financial markets it = i + it and i represent individual country effects. 4. Empirical results 4.1. Descriptive statistics Table A.1 shows the summary statistics. The mean level of FDI scaled by GDP is 2.37%. The mean level of EFPI and private non-guaranteed debt are 0.29% and 0.10%, respectively. Therefore, the volume

144

E.K. Agbloyor et al. / Int. Fin. Markets, Inst. and Money 30 (2014) 137–152

of FDI into Africa far outweighs that of EFPI and private non-guaranteed debt. The average stock market turnover and market capitalization ratios are 11.9% and 31.34% respectively. This is lower than the average stock market turnover and market capitalization ratios of 64.46% and 84.29% for East Asia and the Pacific region over the same period. This suggests that Africa’s capital markets are less developed compared to the East Asia and Pacific region. Average bank and private credit represents 46.40% and 35.46% of GDP respectively are lower compared to bank credit and private credit ratios of 64.38% and 60.74% respectively for the East Asia and Pacific region over the same period. The M2 ratio which measures financial depth averages 38.82% of GDP. This again is much lower compared to a financial depth ratio of 70.48% for East Asia and the Pacific region. Banking systems in East and Pacific Asia show significantly more depth compared to Africa. As regards the financial market variables, Africa’s banking sector exhibits more depth compared to the stock market. Musila and Sigue (2006) noted that the savings rate in sub-Saharan Africa declined from 10.3% during 1974–1980 to only 5.7% during 1991–1996. The mean level of savings of 15.99% suggests a rebound in the savings levels in Africa. The mean level of financial openness of −0.2371 suggests that African economies are still relatively closed despite various reforms to liberalize their capital accounts. The mean level of the civil liberties index of 3.9563 suggests that institutions in Africa remain fairly weak. The correlation matrix shows that multicollinearity is unlikely to be a problem in our data set. FDI exhibits the highest correlation with total capital flows. The finance variables are highly correlated with each other. EFPI exhibits a higher correlation with the market capitalization ratio compared to market turnover.

4.2. Regression results We now discuss the results from our empirical estimations. For each capital flow variable, we report ten different regressions. Five regressions report the effect of the capital flow and financial market development variables on economic growth. We run these five regressions because we use five financial market indicators and include one financial market indicator in the regressions at a time due to potential multicollinearity (see Table A.2). A further five regressions report the effect of the capital flows variables and financial market development on growth taking into consideration the interaction between the capital flow variable and the financial markets indicators. Table A.3 presents the results on FDI and economic growth. The results suggest an overwhelming negative relation between FDI flows and economic growth (see, Models 1, 2, 7, 8, 9 and 10). One plausible explanation is that FDI flows into Africa go mainly into natural resources (mainly oil) which have little linkages with the domestic economy (Akinlo, 2004). Also, FDI flows may crowd out domestic investment by pushing domestic firms out of the market. This is because foreign investors may borrow heavily from domestic financial markets thus reducing the amount of credit available to domestic firms. However, when we interact FDI with financial markets the negative influence of FDI on growth is transformed into a positive one (see Models 2, 8 and 10 where the interaction between FDI and market capitalization, private credit and the M2 ratio turnout to be positive and significant). The results therefore suggest that FDI on its own is likely to have a negative influence on economic growth for African countries. However, countries with strong financial markets benefit more by being able to transform this negative impact of FDI into a positive one. Our findings are similar to Alfaro et al. (2004) who show that local financial markets play an important role in the link between FDI and economic activity. Broadly, our results are consistent with the finance growth-nexus paradigm. The results suggest that financial development whether in the form of an advanced stock market or banking sector helps spur economic growth in Africa. Both stock markets and banks improve the liquidity and tradability of assets in an economy, provide opportunities for economic agents to diversify risk, reduce information asymmetry by collecting information on deficit units, promote savings mobilization and the attraction of foreign capital and improve the corporate governance of firms. In essence, financial development improves the process whereby scarce resources are channelled to the most productive sectors of an economy thereby promoting economic growth. Our results provide support for King and Levine’s

FDI FDI EFPI Debt Total cap. flows Market cap Market turnover Bank credit Private credit M2 GDP Population Savings Financial openness Institutions

EFPI

Debt

Total cap flows

1 −0.0703 1 0.3274 0.0274 1 0.9114 0.2603 0.5479 1 −0.0844 0.6801 0.0238 0.1995 −0.0645 0.2977 0.0969 0.0848 −0.0924 0.4804 0.0854 0.1112 −0.1391 0.5961 0.0525 0.1043 −0.123 0.1488 0.0048 −0.0498 −0.1324 0.3338 −0.0237 0.018 −0.0877 0.1200 −0.0216 −0.0217 0.0066 0.0578 0.0522 0.044 0.2471 −0.1103 0.1724 0.212 0.0136 −0.3097 −0.0584 −0.1044

Market cap Market turnover

Bank credit Private credit

1 0.5356 0.6959 0.815 0.3342 0.6061 0.3141 0.0827 −0.0594 −0.3491

1 0.8594 0.6789 0.696 0.4001 −0.0931 −0.0607 −0.0296

1 0.5093 0.4717 0.3259 0.4979 0.3439 −0.1524 −0.0387 0.0056

1 0.6492 0.6812 0.1690 0.2197 −0.0785 −0.275

M2

GDP

Population Savings

1 0.6141 0.1230 0.2766 0.1476 −0.1034

1 0.7034 1 0.2294 −0.2792 0.0118 −0.0368 0.0909 0.4146

Financial openness

1 0.1593 1 −0.3917 −0.147

Institutions

1

Note: FDI is foreign investment that reflects 10% or more of voting equity and is divided by GDP; EFPI is foreign investment in equity securities divided by GDP; debt represents external debt accruing to the private sector divided by GDP; the market capitalization ratio is the stock market capitalization divided by GDP; stock market turnover is the stock market value traded divided by market capitalization; bank credit is domestic credit to the private sector provided by banks divided by GDP; private credit is domestic credit to the private sector by banks and other financial institutions divided by GDP; M2 is liquid liabilities of the financial sector divided by GDP; population is the log of population size; savings is gross domestic savings divided by GDP; financial openness is Chinn and Ito’s (2008) measure of capital account openness; institutional quality is the civil liberties index and is obtained from Freedom House.

E.K. Agbloyor et al. / Int. Fin. Markets, Inst. and Money 30 (2014) 137–152

Table A.2 Correlation matrix.

145

146

E.K. Agbloyor et al. / Int. Fin. Markets, Inst. and Money 30 (2014) 137–152

(1993) conclusion that finance does not merely follow economic growth but importantly Schumpeter’s (1912) postulation that finance causes or leads economic growth might be right in the African context. Further, we find population to be positively and significantly related to growth in all the estimated models. A large population seems to matter for growth because it contributes to a country’s production and also stimulates high consumption for produced goods. In countries like the U.S., it is well known that consumer spending drives economic activity. Therefore, countries with a large population size benefit more by experiencing higher economic activity. We also find that the level of savings in a country contributes to its economic activity as it is mostly significantly positive in the estimated regressions. Savings are needed to finance investment projects. This is because savings represent funds that can be lent to deficit units through the financial system. Our results are consistent with traditional growth theories that postulate that savings matter for economic growth. Financial openness is also positive and significantly related to growth in all the regression estimates. This suggests that countries with more open capital accounts benefit more by experiencing higher economic activity. This is because financial openness makes it possible for these countries to receive foreign capital to add to their capital stock and achieve investment rates far above those attainable domestically. The results also suggest that institutions play a positive role in spurring economic activity (Alfaro et al., 2004). The negative relation suggests that countries with stronger institutions experience higher economic growth. Institutional arrangements affect corruption, the independence of the judiciary, the rule of law, property rights, social interactions, legal systems, political freedoms and commercial arrangements. Obviously, all these issues matter for the growth outcomes of a country. We estimate the effect of EFPI on economic activity and report the results in Table A.4. Similar to the FDI results reported in Table A.3, we find a negative relation between EFPI and economic activity (see Models 2 and 7). Again, in the absence of good financial markets, the results indicate EFPI negatively influences economic activity although not always significant. These results may be due to the potentially destabilizing effect that EFPI has on stocks markets due to its inherently volatile nature. Due to the fact that these investments are not bolted, foreign investors can easily withdraw their funds from the host economy if more attractive opportunities become available to them and at the least sign of trouble. For example, during the recent global financial crises, stock markets across Africa suffered significant declines because portfolio investors withdrew their funds from these markets (see AfDB, 2009). Countries with liquid stock markets can benefit from EFPI flows as shown by the positive and significant coefficient of the interaction term in Model 4. This is because the impact of EFPI on growth depends on the assumption that well functioning stock markets promote economic growth. Similar to the results reported in Table A.3, population, savings and financial openness have a positive effect on economic growth whilst institutions have a negative impact. The negative sign actually suggests that institutions matter for growth. We report the effect of private debt flows on economic growth in Table A.5. Consistent with the results in Tables A.3 and A.4, debt flows exhibit a significantly negative relation with economic activity in all the estimated models apart from Model 3. This may appear puzzling as we focus on debt accruing to the private sector. Indeed, a negative relation between total external debt and economic growth is not surprising especially when a country is characterized by high levels of debt (see for example, Kumar and Woo, 2010; Imbs and Ranciere, 2007; Pattilo et al., 2002, 2004). Alfaro et al. (2004) explain that the observed negative influence of debt on growth may be due to sovereign to sovereign lending and aid flows which are allocated based on factors such as political economy considerations. Rationalizing the negative effect of private debt flows on growth therefore becomes difficult. However, this may be due to the fact that foreign private lenders lending to firms in Africa are exposed to higher levels of information asymmetry. Like Choong et al. (2010) we find that advanced financial markets are able to transform the negative debt effect into a positive one as indicated by the interaction term (see Model 2 where the interaction between private debt and stock market turnover turns out to be positive and significant). The results therefore suggest that in the absence of a well developed financial market, debt flows are likely to be misallocated. Finally, we present the result on total capital flow and economic growth in Table A.6. Controlling for population, savings, financial openness and institutional quality, we find a negative relation between total capital flow and economic growth (see Models 1, 2, 6, 7, 8, 9, 10). This finding is not surprising

Table A.3 FDI and economic growth in Africa: the role of domestic financial markets.

FDI Market capitalization

(2)

(3)

(4)

(5)

(6)

(7)

(8)

(9)

(10)

−3.8849*** (1.4397) 0.2198*** (0.0779)

−5.6250*** (2.0116) −0.0399 (0.1163)

−4.9694 (5.0875)

−5.7341 (7.2760)

−0.9604 (1.6042)

−0.0487 (1.5100)

−2.8650* (1.5782)

−3.3013** (1.5755)

−4.2719* (2.5142)

−10.7188** (4.7424)

0.0035 (0.0042)

−0.0021 (0.0039) 0.3790*** (0.0625)

0.4020*** (0.0684) 0.5905*** (0.1113)

0.4548*** (0.1571) 0.7796*** (0.1854)

Stock market turnover Bank credit Private credit

1.2683*** (0.0806) 1.0799*** (0.2404) 0.0363*** (0.0119) −0.0408*** (0.0111)

5.8756** (2.9928) 1.2299*** (0.0673) 1.0478*** (0.2086) 0.0366*** (0.0116) −0.0386*** (0.0098)

1.2523*** (0.1274) 1.1948*** (0.3588) 0.0512*** (0.0125) −0.0413*** (0.0158)

−0.423 (0.6433) 21.3663** (10.7057) 1.3051*** (0.1555) 1.4073*** (0.4305) 0.0605*** (0.0163) −0.0534*** (0.0170)

181 12 142.74 0 9.791 0.0204

181 12 132.13 0 9.55 0.0228

184 12 104.47 0 5.638 0.1306

184 12 47.64 0 1.216 0.7492

M2

1.3034*** (0.1581) 1.1663*** (0.2605) 0.0524*** (0.0090) −0.0175 (0.0171)

7.1377*** (2.7749) 1.3779*** (0.1641) 1.2291*** (0.2719) 0.0585*** (0.0094) −0.0208 (0.0168)

169 13 62 0 4.594 0.2041

169 13 55.57 0 5.149 0.1612

Interaction term Population Savings Financial openness Institutions Observations No. of countries F Prob > F Hansen J Chi Sq

1.7164*** (0.4606) 0.8853 (1.0245) 0.0978** (0.0466) −0.0195 (0.0277)

0.1542 (0.1747) 1.7278*** (0.4632) 0.4309 (1.0072) 0.0696* (0.0396) −0.0252 (0.0255)

96 11 9.66 0 1.247 0.7416

96 11 8.42 0 0.363 0.9477

1.2166*** (0.0844) 1.0889*** (0.1981) 0.0412*** (0.0092) −0.0384*** (0.0099)

−0.4177 (1.2966) 1.1936*** (0.0687) 0.9918*** (0.1952) 0.0369*** (0.0086) −0.0351*** (0.0092)

181 12 210.88 0 7.841 0.0494

181 12 197.81 0 7.836 0.0495

Note: FDI is foreign investment that reflects 10% or more of voting equity and is divided by GDP; the market capitalization ratio is the stock market capitalization divided by GDP; stock market turnover is the stock market value traded divided by market capitalization; bank credit is domestic credit to the private sector provided by banks divided by GDP; private credit is domestic credit to the private sector by banks and other financial institutions divided by GDP; M2 is liquid liabilities of the financial sector divided by GDP; population is the log of population size; savings is gross domestic savings divided by GDP; financial openness is Chinn and Ito’s (2008) measure of capital account openness; institutional quality is the civil liberties index and is obtained from Freedom House. Model 2 interacts FDI with stock market capitalization, Model 4 interacts FDI with stock market turnover, Model 6 interacts FDI with bank credit, Model 8 interacts FDI with private credit and Model 10 interacts FDI with the M2 ratio. * Significant at 10%. ** ***

147

Significant at 5%. Significant at 1%.

E.K. Agbloyor et al. / Int. Fin. Markets, Inst. and Money 30 (2014) 137–152

(1)

148

Table A.4 Foreign equity portfolio investments and economic growth in Africa: the role of domestic financial markets.

EFPI Market capitalization

(2)

(3)

(4)

(5)

(6)

(7)

(8)

(9)

(10)

−1.1014 (1.0426) 0.1299** (0.0546)

−0.4958 (3.0113) 0.1259* (0.0756)

−0.3929 (0.7254)

−10.0498** (4.5881)

−0.8528 (0.7842)

−4.6731 (8.0400)

−3.1983*** (1.0991)

−15.55 (28.6592)

−0.7025 (0.6602)

−34.7311 (30.9868)

0.0008 (0.0008)

−0.0019 (0.0017) 0.4107*** (0.0527)

0.4007*** (0.0569) 0.7414*** (0.0987)

0.6439*** (0.1901) 0.6892*** (0.1328)

Stock market turnover Bank credit Private credit

1.2392 (0.0563) 0.8481*** (0.1122) 0.0203*** (0.0064) −0.0273*** (0.0064)

9.4439 (21.5413) 1.1855*** (0.1071) 0.8353*** (0.1507) 0.0255* (0.0138) −0.0300*** (0.0099)

1.1547*** (0.0706) 0.8895*** (0.1142) 0.0405*** (0.0054) −0.0205*** (0.0076)

0.4452 (0.2990) 61.8355 (55.8622) 1.1298*** (0.0877) 0.9174*** (0.1607) 0.0383*** (0.0083) −0.0251*** (0.0095)

194 13 198.7 0 8.897 0.0307

194 13 91.41 0 8.008 0.0458

197 13 188.61 0 6.353 0.0957

197 13 91.73 0 5.794 0.1221

M2

1.3178 (0.1372) 0.8411*** (0.1412) 0.0407*** (0.0073) −0.0200 (0.0159)

−0.0324 (1.4171) 1.3157*** (0.1364) 0.8522*** (0.1402) 0.0420*** (0.0075) −0.0177 (0.0168)

182 14 93.12 0 14.162 0.0027

182 14 90.7 0 14.507 0.0023

Interaction term Population Savings Financial openness Institutions Observations Countries F Prob > F Hansen J Chi Sq

***

1.6131 (0.1568) 0.3884** (0.17) 0.0658*** (0.0138) −0.0274* (0.0154)

0.2511** (0.0001) 1.2960*** (0.1823) 0.3044 (0.2341) 0.0778*** (0.0170) −0.0470*** (0.0171)

107 12 61.99 0 5.079 0.1661

107 12 32.79 0 1.967 0.5793

***

1.2317 (0.0614) 0.9435*** (0.0950) 0.0341*** (0.0050) −0.0333*** (0.0073)

2.5990 (4.9491) 1.2126*** (0.0751) 0.9618*** (0.0960) 0.0357*** (0.0056) −0.0342*** (0.0077)

194 13 236.94 0 6.65 0.0839

194 13 179.91 0 7.239 0.0647

***

***

Note: EFPI is foreign investment in equity securities divided by GDP; the market capitalization ratio is the stock market capitalization divided by GDP; stock market turnover is the stock market value traded divided by market capitalization; bank credit is domestic credit to the private sector provided by banks divided by GDP; private credit is domestic credit to the private sector by banks and other financial institutions divided by GDP; M2 is liquid liabilities of the financial sector divided by GDP; population is the log of population size; savings is the gross domestic savings divided by GDP; financial openness is Chinn and Ito’s (2008) measure of capital account openness; institutional quality is the civil liberties index and is obtained from Freedom House. Model 2 interacts EFPI with stock market capitalization, Model 4 interacts EFPI with stock market turnover, Model 6 interacts EFPI with bank credit, Model 8 interacts EFPI with private credit and Model 10 interacts EFPI with the M2 ratio. * Significant at 10%. ** ***

Significant at 5%. Significant at 1%.

E.K. Agbloyor et al. / Int. Fin. Markets, Inst. and Money 30 (2014) 137–152

(1)

Table A.5 Private debt flows and economic growth in Africa: the role of domestic financial markets.

Private debt Market capitalization

(2)

(3)

(4)

(5)

(6)

(7)

(8)

(9)

(10)

−3.1849** (1.5888) 0.1946*** (0.0614)

−3.7860** (1.9111) 0.0912* (0.0491)

−1.7973 (2.6376)

−6.3935* (3.4453)

−3.5340** (1.5858)

−4.9092* (2.9271)

−4.2564*** (1.6266)

−4.4763** (1.9356)

−3.7376* (2.1279)

−7.2767* (3.9727)

0.0013 (0.0011)

0.0016** (0.0008) 0.4012*** (0.0531)

0.3794*** (0.0635) 0.8007*** (0.0862)

0.7869*** (0.0883) 0.7261*** (0.1318)

Stock market turnover Bank credit Private credit

1.1849*** (0.0613) 1.0127*** (0.1104) 0.0237*** (0.0055) −0.0301*** (0.0068)

2.2140 (2.8307) 1.1739*** (0.0629) 1.0257*** (0.1179) 0.0249*** (0.0060) −0.0305*** (0.0067)

1.1098*** (0.0872) 0.9524*** (0.1306) 0.0431*** (0.0054) −0.0232*** (0.0088)

0.8416*** (0.1808) 14.5438 (9.2130) 1.0763*** (0.0847) 0.9977*** (0.1386) 0.0437*** (0.0057) −0.0229*** (0.0087)

179 12 218.59 0 2.291 0.5143

179 12 186.2 0 2.417 0.4904

180 12 198.43 0 3.588 0.3096

180 12 152.85 0 3.198 0.362

M2

1.2628*** (0.1579) 0.9153*** (0.1519) 0.0407*** (0.0074) −0.0186 (0.0166)

3.6685** (1.6563) 1.2841*** (0.1527) 0.9540*** (0.1591) 0.0498*** (0.0069) −0.0226 (0.0164)

165 13 90.33 0 5.657 0.1296

165 13 86.38 0 8.422 0.038

Interaction term Population Savings Financial openness Institutions Observations Countries F Prob > F Hansen J Chi Sq

1.5521*** (0.2147) 0.2504 (0.2079) 0.0763*** (0.0141) −0.0187 (0.0154)

0.1547 (0.0968) 1.6118*** (0.2210) 0.5289* (0.3175) 0.0711*** (0.0141) −0.0175 (0.0138)

95 11 53.54 0 6.241 0.1004

95 11 46.61 0 3.273 0.3514

1.1936*** (0.0643) 1.0862*** (0.1221) 0.0369*** (0.0049) −0.0366*** (0.0076)

3.6243 (3.6786) 1.1602*** (0.0721) 1.1256*** (0.1460) 0.0392*** (0.0058) −0.0378*** (0.0075)

179 12 251.02 0 0.922 0.82

179 12 206.87 0 1.007 0.7996

Note: Private debt represents external debt accruing to the private sector divided by GDP; the market capitalization ratio is the stock market capitalization divided by GDP; stock market turnover is the stock market value traded divided by market capitalization; bank credit is domestic credit to the private sector provided by banks divided by GDP; private credit is domestic credit to the private sector by banks and other financial institutions divided by GDP; M2 is liquid liabilities of the financial sector divided by GDP; population is the log of population size; savings is the gross domestic savings divided by GDP; financial openness is Chinn and Ito’s (2008) measure of capital account openness; institutional quality is the civil liberties index and is obtained from Freedom House. Model 2 interacts private debt with stock market capitalization, Model 4 interacts private debt with stock market turnover, Model 6 interacts private debt with bank credit, Model 8 interacts private debt with private credit and Model 10 interacts private credit with the M2 ratio. * Significant at 10%. ** ***

149

Significant at 5%. Significant at 1%.

E.K. Agbloyor et al. / Int. Fin. Markets, Inst. and Money 30 (2014) 137–152

(1)

150

Table A.6 Total private capital flows and economic growth: the role of domestic financial markets.

Total capital flows Market capitalization

(2)

(3)

(4)

(5)

(6)

(7)

(8)

(9)

(10)

−2.6340*** (1.0277) 0.2873*** (0.0777)

−3.9463*** (1.5429) −0.0159 (0.1644)

−0.0009 (1.1939)

−2.4918 (2.0382)

−1.1481 (0.7432)

−2.2101* (1.2780)

−1.9989*** (0.7147)

−2.5873*** (1.0509)

−2.4990** (1.1420)

−5.5386*** (2.1400)

0.0012 (0.0012)

−0.0012 (0.0016) 0.3955*** (0.0589)

0.3317*** (0.0777) 0.7126*** (0.0981)

0.6075*** (0.1415) 0.7544*** (0.1616)

Stock market turnover Bank credit Private credit

1.2633*** (0.0676) 1.0687*** (0.1853) 0.0310*** (0.0087) −0.0397*** (0.0087)

2.4970* (1.4741) 1.2270*** (0.0698) 1.1832*** (0.2321) 0.0379*** (0.0116) −0.0419*** (0.0097)

1.1965*** (0.0984) 1.1330*** (0.24741) 0.0490*** (0.0092) −0.0369*** (0.0118)

0.1232 (0.3193) 11.3693** (4.9742) 1.1851*** (0.0980) 1.2656*** (0.2702) 0.0541*** (0.0100) −0.0411*** (0.0117)

179 12 151.66 0.0000 3.0880 0.3783

179 12 114.47 0.0000 1.640 0.6504

180 12 117.47 0.0000 4.5420 0.2086

180 12 81.62 0.0000 2.1100 0.5499

M2

1.3109*** (0.1637) 1.1289*** (0.2476) 0.0472*** (0.0090) −0.0233 (0.0178)

2.7579** (1.3941) 1.3807*** (0.1794) 1.3852*** (0.3318) 0.0615*** (0.0099) −0.0361* (0.0196)

165 13 56.36 0.0000 2.701 0.4400

165 13 48.22 0.0000 1.690 0.6391

Interaction term Population Savings Financial openness Institutions Observations Countries F Prob > F Hansen J Chi Sq

1.4559*** (0.2080) 0.3219 (0.2724) 0.0757*** (0.0157) −0.0211 (0.0146)

0.07476* (0.0455) 1.4998*** (0.2474) 0.4198 (0.4846) 0.0760*** (0.0223) −0.0260 (0.0163)

95 11 47.38 0.0000 7.923 0.0476

95 11 18.67 0.0000 1.3150 0.7255

1.2472*** (0.0717) 1.1508*** (0.1592) 0.0407*** (0.0068) −0.0415*** (0.0083)

1.5579 (0.9834) 1.2301*** (0.0711) 1.3198*** (0.2406) 0.0473*** (0.0095) −0.0460*** (0.0103)

179 12 192.96 0.0000 4.8010 0.1870

179 12 138.55 0.0000 2.8190 0.4204

Note: Total private capital flows is the summation of FDI, EFPI and private non-guaranteed debt; the market capitalization ratio is the stock market capitalization divided by GDP; stock market turnover is the stock market value traded divided by market capitalization; bank credit is domestic credit to the private sector provided by banks divided by GDP; private credit is domestic credit to the private sector by banks and other financial institutions divided by GDP; M2 is liquid liabilities of the financial sector divided by GDP; population is the log of population size; savings is the gross domestic savings divided by GDP; financial openness is Chinn and Ito’s (2008) measure of capital account openness; institutional quality is the civil liberties index and is obtained from Freedom House. Model 2 interacts total capital flows with stock market capitalization, Model 4 interacts total capital flows with stock market turnover, Model 6 interacts total capital flows with bank credit, Model 8 interacts total capital flows with private credit and Model 10 interacts total capital flows with the M2 ratio. * Significant at 10%. ** ***

Significant at 5%. Significant at 1%.

E.K. Agbloyor et al. / Int. Fin. Markets, Inst. and Money 30 (2014) 137–152

(1)

E.K. Agbloyor et al. / Int. Fin. Markets, Inst. and Money 30 (2014) 137–152

151

as the various components of private capital flows exhibit a negative relation with economic growth. The negative effect means that private capital flows adversely affect a country’s growth outcome. This result can be explained in the sense that capital flows tend to be volatile. Financial markets are able to transform this negative effect of capital flows into a positive one because they help to efficiently allocate foreign capital flows towards productive investments (see Models 2, 4, 8 and 10 where the interaction between total capital flows and stock market capitalization, stock market turnover, private credit and the M2 ratio respectively turnout to be positive and significant). The results therefore suggest that in the absence of well functioning domestic financial markets, private capital flows will have a damaging impact on economic growth. Our results are similar to Bailliu (2000) who find that countries with advanced banking systems benefit more from private capital flows (Table A.6).

5. Conclusion This study examines the relation between the various forms of private capital flows and economic growth in Africa. Our capital flows variables include FDI, EFPI, private non-guaranteed debt and aggregate private capital flows. In all the empirical analysis conducted, we control for population size, savings, financial openness and institutional quality as these factors matter for economic activity. We find overwhelming evidence that private capital flows have a detrimental effect on economic growth in Africa. However, we take into consideration the fact that capital flows may not have an independent influence on growth and interact the capital flows variables with financial market indicators. When we do this, we find an unambiguous positive influence between the capital flows variables and financial markets on growth. The key issue that emerges is that capital flows may be detrimental in countries with relatively underdeveloped financial markets. Financial markets matter in the growth process because they help allocate foreign capital towards productive ventures. Also, countries with weak financial markets may be more vulnerable to financial and exchange rate crises resulting in the outflow of foreign capital and lowering their long-term economic growth. Undeveloped financial markets therefore seem to frequently misallocate foreign capital. This study contributes to the literature on absorptive capacities. The findings suggest that financial markets are a necessary absorptive capacity for the private financial flows that we examine in the African context. The results imply that unfettered capital flows may have a negative impact on economic activity. Therefore, countries should endeavour to develop their domestic financial markets to positively intermediate foreign capital flows to spur economic growth.

References Acemoglu, D., Johnson, S., Robinson, J., 2004. Institutions as the Fundamental Cause of Long-run Economic Growth National Bureau of Economic Research, NBER Working Paper No. 10481. NBER, Cambridge, Mass. Adjasi, C.K.D., Biekpe, N.B., 2006. Stock market development and economic growth: the case of selected African countries. African Development Bank 18 (1), 144–161. AfDB, 2009. The Impact of the Global Financial and Economic Crises on Africa. Akinlo, E.A., 2004. Foreign direct investment and growth in Nigeria: an empirical investigation. Journal of Policy Modelling 26 (5), 627–639. Alfaro, L., Chanda, A., Kalemli-Ozcan, S., Sayek, S., 2004. FDI and economic growth: the role of local financial markets. Journal of International Economics 64, 89–112. Allen, D.S., Ndikuma, L., 2000. Financial intermediation and economic growth in southern Africa. Journal of African Economies 9 (2), 132–160. Bailliu, J.N., 2000. Private Capital Flows, Financial Development, and Economic Growth in Developing Countries. Bank of Canada Working Paper 15. Balasubramanyam, V.N., Salisu, M., Sapsford, D., 1996. FDI and growth in EP and IS countries. Economic Journal 106, 92–105. Baum, C.F., 2009. Instrumental Variables and Panel Data Methods in Economics and Finance. Boston College. Beck, T., Levine, R., Loayza, N., 2000. Finance and the sources of growth. Journal of Financial Economics 58, 261–300. Bekaert, G., Harvey, C., 1998. Capital Flows and the Behavior of Emerging Market Equity Returns. NBER Working Paper Series No. 6669. Bekaert, G., Harvey, C., 2000. Foreign Speculators and Emerging Equity Markets. Journal of Finance 55, 565–613. Blomstrom, M., Lipsey, R.E., Zejan, M., 1992. What Explains Developing Country Growth?, Working Paper Series No. 4132. National Bureau for Economic Research. Borensztein, E., De-Gregorio, J., Lee, J.W., 1998. How does foreign direct investment affect economic growth? Journal of International Economics 45, 115–135.

152

E.K. Agbloyor et al. / Int. Fin. Markets, Inst. and Money 30 (2014) 137–152

Brambila-Macias, J., Massa, I., 2010. The global financial crises and sub-Saharan Africa: the effect of slowing capital flows on growth. African Development Review 22, 366–377. Chinn, M.D., Ito, H., 2008. A new measure of financial openness. Journal of Comparative Policy Analysis 10 (3), 309–322. Choong, C.-K., Baharumshah, A.Z., Yuzop, Z., Habibullah, M.S., 2010. Private capital flows, stock market and economic growth in developed and developing countries: a comparative analysis. Japan and the World Economy 22 (2), 107–117. Durham, J.B., 2004. Absorptive capacity and the effects of foreign direct investment and foreign equity portfolio investment on economic growth. European Economic Review 48, 285–306. Easterly, W., Levine, R., 1997. Africa’s growth tragedy: policies and ethnic divisions. The Quarterly Journal of Economics 112 (4), 1203–1250. Froot, K., Stein, J.C., 1991. Exchange rates and foreign direct investment: an imperfect capital markets approach. Quarterly Journal of Economics 106, 1191–1217. Hermes, N., Lensink, R., 2003. Foreign direct investment, financial development and economic growth. Journal of Development Studies 41, 142–163. Imbs, J., Ranciere, R., 2007. The Overhang Hangover. Mimeo. International Monetary Fund, 2011. Regional Economic Outlook Sub-Saharan Africa (October). IMF, Washington, DC. Kendall, J., 2012. Local financial development and growth. Journal of Banking and Finance 36, 1548–1562. King, R.G., Levine, R., 1993. Finance and growth: Schumpeter might be right. Quarterly Journal of Economics 108 (3), 717–737. Kumar, M.S., Woo, J., 2010. Public Debt and Growth. IMF Working Paper No 174 (Washington: International Monetary Fund). Mankiw, N.G., Romer, D., Weil, D.N., 1992. A contribution to the empirics of economic growth. The Quarterly Journal of Economics 107 (2), 407–437. Manu, L., Adjasi, C., Abor, J., Harvey, S., 2011. Financial stability and economic growth: a cross-country study. International Journal of Financial Services Management 5 (2), 121–138. Musila, J.W., Sigue, S.P., 2006. Accelerating foreign direct investment flow to Africa: from policy statements to successful strategies. Managerial Finance 32 (7), 577–593. Omran, M., Bolbol, A., 2003. Foreign direct investment, financial development and economic growth: evidence from the Arab countries. Review of Middle East Economics and Finance 1 (3), 231–249. Pattilo, C., Poirson, H., Ricci, L., 2002. External Debt and Growth. IMF Working Paper No 69 (Washington: International Monetary Fund). Pattilo, C., Poirson, H., Ricci, L., 2004. What are the Channels through which External Debt Affects Growth? IMF Working Paper No. 15 (Washington: International Monetary Fund). Romero-Avila, D., 2007. Finance and growth in the EU: new evidence from the harmonization of the banking industry. Journal of Banking and Finance 31, 1937–1954. Schumpeter, J.A., 1912. The theory of economic development. In: Brookings Papers on Economic Activity. Harvard University Press, Cambridge, MA, pp. 141–195. Solow, R.M., 1956. A contribution to the theory of economic growth. Quarterly Journal of Economics 70, 65–94. Soto, M., 2000. Capital Flows and Growth in Developing Countries: Recent Empirical Evidence, OECD Development Centre, Working Paper No. 160. United Nations, 2011. World Economic Situations and Prospects. United Nations Economic Commission for Africa (UNECA), 2006. Capital flows and development financing in Africa. Wheeler, D., Mody, A., 1992. International investment location decisions: the case of US firms. Journal of International Economics 33, 57–76. World Bank, 1998. Global Development Finance Report. World Bank, Washington, DC. World Bank, 2001. Global Development Finance Report. World Bank, Washington, DC.