“Crowding In” Effect of Public Investment on Private Investment Revisited

Current investment trends in emerging market and developing economies are not enough to meet the needs of their growing populations and will fall short of achieving the Sustainable Development Goals related to human and physical capital development. Public investment can play a critical role in addressing this shortfall, especially if it can crowd-in private investment. Using theory and panel data for 109 developing countries from 1980–2019, this paper investigates whether public investment crowds in or crowds out private investment. The paper also explores how the relationship changes across different groups of countries and under different institutional settings. The analysis uses changes in predicted disbursements on loans from official creditors to developing country governments as an instrument for changes in public investment. The findings show that public investment is a complement to private investment, raising the marginal productivity of the latter. As a result, an extra dollar of public investment raises private investment by 1.6 dollars. The findings also reveal stronger evidence of crowding-in of private investment in low-income countries and Sub-Saharan Africa, where investment needs are greatest. Finally, the findings are embedded in a model with imperfect capital markets, which shows that public investment can be used as an effective vehicle to address underinvestment issues induced by capital market distortions.