The Effect of Public Capital on Private Investment in Kenya

Abstract

It is widely agreed that investment is important because it raises economy's productive capacity by accelerating advancement in technology and adoption of new techniques that enhances industrial growth (Ahmad et al, 2009). According to Dornbush (1999) investment depends on number of factors and is therefore volatile thus a major cause of fluctuations of GDP during business cycle. The classical economists, Smith and Ricardo argued that national prosperity and growth can be achieved through market mechanisms without government intervention which was seen as unnecessary in regulating the economy. Keynes (1936), on the other hand advocated for government intervention to regulate savings and investment behavior of the society. Development investments such as provision of infrastructure may positively affect private investment through reduction in cost of production. In addition, government consumption expenditure positively affects private investment through increased aggregate demand channel but may also have negative effect on investment due to increased budget deficits and future taxes caused by lack of complementary effects on private investment (Alfred and Sagales, 2001). The above position notwithstanding, literature on public investment stimulating or crowding-out private investment has taken a center stage in policy debate especially in developing countries (Ismihan et al., 2005; Rashid and Ahmad, 2005).Public investment plays important role in the socioeconomic development of a country even though these investments are generally considered to be less efficient compared to private investment (Agyie, 2017). Consequently, policy-makers generally assert that effective public investment will result in high relative return in the private sector. However, one view suggests that high levels of government borrowing from domestic market to finance public spending acts as substitute to private investment (Hermes and Lensink, 2003). Further, literature alludes that economic agents are rational and therefore when government spending is increased private saving also goes up in equal measure which results in no first-order effect on private investment (Barro, 1974). These divergent views have given rise to several studies assessing the relationship between public and private investment albeit mixed results (Laopodis, 2001b).While the argument about the effect of public investment in the economy mainly seems to validate crowding-in effect in developing countries and the opposite in developed economies, evidence of such findings remain inconclusive across countries and regions (Munthali, 2012). Several studies have looked into the effect of public investment on output growth (for example, Ahmed, 2009; Erden and Holcombe, 2006; Ahmed and Qayyum, 2007; Bucci and Del 2012). Other studies have analyzed the factors influencing private investment (for example, Martinez-lopez, 2006; Kamrul and Ruhul, 2011). However, the findings vary from one study to another with some of the studies having found private capital to be more productiv...