Cross-Country Evidence on the Link between the Level of Infrastructure and Capital Inflows

1 Introduction

The aim of this paper is to shed further light on the determinants of capital inflows to developing
countries. In particular, the relationship between the level of infrastructure in these countries
and their ability to attract external capital is investigated. The rationale of this paper becomes
evident when examining the literature on the provision of public capital and productivity. Pub-
lic investment can generate important positive spillover effects for private sector investment.¹
Aschauer (1989) analyses the relationship between public capital and production, using aggre-
gated data of the United States. His results point out that the United States’ productivity
decline of the 1970s was due to under investment in infrastructure. By contrast, one could argue
that public capital is endogenous so that the causation runs from productivity to public invest-
ment (Fernald (1999)). The author explores that the aggregate correlation between productivity
and public capital in the U.S. primarily reflects the causation from public capital to productiv-
ity. Fernald considers roads and his evidence suggests that the massive road building during
the 1960s offered a one-time increase in the level of productivity. Demetriades and Mamuneas
(2000) create an intertemporal model of output and employment to test for the effects of pub-
lic infrastructure capital and their rates of return. They confirm Aschauer’s finding for twelve
OECD countries in the long-run. The authors argue that the productivity of public capital is
significantly lower than the one of private capital in the short-run but more productive in most
countries analysed in the long-run. Their findings suggest that the short-run rates of return to
public capital are rather low while the long-run rates of return tend to be relatively high. Hence,
public capital is often oversupplied in the short-run and undersupplied in the long-run. They
conclude that it is important to consider the effects of public capital not only on current but
also on future producer decisions. In the context of international capital, Clarida (1993) looks at
the relationship among international capital flows, public investment and growth. He develops
a neoclassical growth model under perfect international capital mobility in which private and
public capital are complements in production. Empirically he finds out that productivity and
public capital are cointegrated in four OECD Countries.² Nevertheless, the question whether
productivity is exogenous or endogenous with respect to public capital cannot be answered so
that the structural relationship needs to be investigated further.

This paper attempts to explain the structural relationship between the initial public in-
frastructure conditions of countries and capital movements in a cross-section of countries. It
concentrates on different types of capital stocks and flows, namely total liabilities, portfolio eq-

¹ For an overview on this literature see Gramlich (1994).

²Namely the USA, Germany, France and the United Kingdom.

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