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ANTHOLOGY

Direct and Total Effects of Foreign Capital Inflows on Savings

RATI RAM Washington State University

The importance of foreign capital inflows (FIG) in economic development has been de- bated extensively. In particular, the effect of FKI on domestic savings has received consider- able attention in the context of the fairly con- sistent finding of a sizable negative coefficient of FIG in estimated savings equations. Gupta [Kyklos, 1975, pp. 358-74] made a distinction between the 'direct' and 'total' effects of FKI on savings, the former being the coefficient of FKI in the structural savings equation and the latter the coefficient of FKI in the reduced form of the savings function in a simultaneous equations framework. Postulating a seven- equation system, and using data for 40 develop- ing countries for 1960's, he estimated by 2SLS the structural system, computed the reduced form coefficient of FIG in the savings equation, and concluded that " . . . the negative impact o f . . . foreign capital inflows is much less pro- nounced than that indicated by the structural equation," "the single equation models . . , have greatly exaggerated the negative impact of such flows," and that the "role of foreign resource inflows is quite small" in regard to savings.

Since Gupta's data pertain to the 1960's, it is of obvious interest to examine the relevant coefficients for a more recent period. This note reports, for the period 1971-75, the coefficients of FKI in the structural and reduced form sav- ings equations with the same model and pro- cedure as Gupta's for the same 40-country sample (but without the break-up of FKI into different components). To facilitate compari- son, the corresponding coefficients for 1960's are also reported.

Strue.Coef. Reduced Form of FKI Coef.of FKI

('direct' effect) ('total' effect)

1960's -1.196 -.91 1971-75 -1.035 -.87

The more recent data indicate a slightly smaller adverse effect of savings but the broad magnitudes are similar. More important, how- ever, it is not obvious either that the direct effect, reflected in the structural coefficient, greatly exceeds the true effect, or that the total effect is 'small' in any sense. Indeed, the reduced form coefficients suggest that a dollar of foreign capital inflow reduced, on the whole, domestic savings by 87 to 91 cents, which are tremen- dous 'displacement' effects.

Of course, one might believe that neither the structural nor the reduced form coefficient of FKI in the savings function in such a system re- flects the 'true' effect of FKI. Some serious ob- jections to Gupta's model may seem possible, even though estimation of the structural and the reduced form savings equations does not necessarily require the entire model specifica- tion but only a list of the system's predeter- mined variables. Also, Weisskopf [REStat, 1972, pp. 67-78] has discussed a possible problem concerning the interpretation of FKI coefficients based on ex post, rather than ex ante, savings. Nevertheless, to the extent the reduced form coefficient of FKI in such a static, simultaneous equations framework does reflect the total effect of FKI on savings, it is difficult to say that the effect is small for the 1970's (or even the 1960's); nor is it observed that the structural coefficient greatly exagger- ates the true effect in the given sample. Other samples might, however, yield different results.

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