Banking crises and economic growth in developing countries: Why privileging foreign direct investment over external debt?

Abstract

The impact of external financing on the economies of developing countries is still a subject of debate among economists and policy makers. The objective of this paper is to contribute to this debate by shedding light on the interaction between foreign direct investment (FDI) and external debt. To this end, we begin by formulating an overlapping generation growth model that integrates a banking sector and find two complementary results.First, we show that external financing boosts investment projects and accelerates the dynamic of capital accumulation and economic growth. The second one mitigates this channel by showing two opposite indirect effects of external debt and FDI. Indeed, while external debt financing increases the vulnerability to a bank run that generates a recessionary impact on economic growth, FDI attenuates this recessionary impact and plays the role of a shock absorber. We empirically confirm these results for 67 developing countries over the period 1972-2015 using the GMM estimation of growth models and panel-logit models to predict the determinants of banking crises. Hence, this study provides a comprehensive assessment of developing countries' involvement in

Reassessing the impact of health expenditure on income growth in the face of the global sanitary crisis: the case of developing countries

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Examining the Non-Linear Impact of External Debt on Economic Convergence

“…Unfavorable structural conditions especially in developing economies underline the importance of foreign loans in facilitating infrastructural developments which may contribute to better economic growth if the borrowed funds are used effectively (Agenor and Montiel, 2015). In addition, external financing encourages investment projects and accelerates the dynamic of capital accumulation and thereby economic growth (Gaies and Nabi, 2021).…”

“…In addition, accumulation in foreign debt burden is indicative of a higher default risk, which might become a concern for creditors. Consequently, creditors might require a higher borrowing cost premium and discourage capital flows, impeding future growth potentials (Gaies and Nabi, 2021). Mensah et al (2017) identify another reason why more debt leads to slower growth.…”

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