Increasing private capital flows to developing countries: The role of physical and financial infrastructure

Combining the classical “push-pull factors” and the “Lucas paradox” theoretical approaches, and taking into account the relationship between components of capital flows -through Three Stage Least Square (3SLS) estimations-, this paper shows that physical infrastructure and financial development positively affect Foreign Direct Investment (FDI) and portfolio investment in developing countries. The analysis highlights the importance of non-linearity effects when assessing the role of financial development for portfolio investment inflows. Lax monetary policy and excessive credit provision could weaken the financial system and significantly reduce portfolio investment flows. The results also show that for Sub-Saharan African countries, better physical infrastructure tends to attract more FDI.