Financial Determinants of Domestic Investment in Sub-Saharan Africa: Evidence from Panel Data LEONCE NDIKUMANA * University of Massachusetts, Amherst, USA Summary. Ð This study investigates the eects of ®nancial development on domestic investment in a sample of 30 sub-Saharan African countries. It is based on a dynamic serial-correlation investment model including various indicators of ®nancial development, controlling for country- speci®c ®xed eects and non®nancial factors of investment. The results indicate a positive relationship between domestic investment (total investment and private investment) and various indicators of ®nancial development. Higher ®nancial development leads to higher future levels of investment, implying a potent long-run eect of ®nancial development on domestic investment. The ®ndings imply that ®nancial development can stimulate economic growth through capital accumulation. Ó 2000 Elsevier Science Ltd. All rights reserved. Key words Ð ®nance, investment, development, growth, sub-Saharan Africa 1. INTRODUCTION Since the beginning of the 1980s, investment rates have fallen in the majority of sub-Saharan African countries. 1 In more than half of the 30 countries included in this study, investment rates in the 1980s and 1990s are lower than the rates achieved in the 1970s. This decline in in- vestment is a matter of concern given the close connection between the level of investment and the rate of economic growth as documented in recent studies (Ben-David, 1998; Chari, Kehoe & McGrattan, 1997; Barro, 1991; Khan & Reinhart, 1990; Kormendi & Meguire, 1985). It is therefore worthwhile investigating the factors that determine the level of domestic investment in these countries. This paper investigates the role of ®nancial factors in determining domestic investment in sub-Saharan Africa, controlling for non®nan- cial factors of investment. The study covers the majority of the economies in the largest area of the developing world where issues of stag- nation of domestic investment and underde- veloped ®nancial systems are at the forefront of the current debate in economic develop- ment. The premise of this study is that ®nan- cial development facilitates the channeling of resources from savers to the highest-return investment activities, increases the quantity of funds available for investment, and thus miti- gates the liquidity constraints faced by entre- preneurs. Thus a large and liquid ®nancial system reduces the overall costs and risks of investment, which stimulates capital accumu- lation. The analysis is based on a reduced-form in- vestment model that relates a countryÕs do- mestic investment to the level of ®nancial development while controlling for other non®- nancial factors. Following a standard practice in panel data analysis, the investment equation is speci®ed as a dynamic serial correlation model (see Hsiao, 1986; Anderson & Hsiao, 1982, 1981). To test the eects of ®nancial de- velopment on investment four indicators are World Development Vol. 28, No. 2, pp. 381±400, 2000 Ó 2000 Elsevier Science Ltd. All rights reserved Printed in Great Britain 0305-750X/00/$ - see front matter PII: S0305-750X(99)00129-1 www.elsevier.com/locate/worlddev * I am indebted to Mohan Rao for guidance and constructive comments. I thank James Boyce, James Crotty, Carol Heim, and Robert Pollin who provided stimulating suggestions on earlier drafts of this manu- script. I am grateful to Dale Ballou, Steven Fazzari, John Keating, and Andrew Meyer for technical support and to an anonymous referee for comments and suggestions. Of course, none of these individuals agrees with all of the views expressed in this paper. The initial research on this study bene®ted from ®nancial support from the University of Massachusetts. Vamsicharan Vakulabharanam provided excellent research assistance. Final revision accepted: 26 June 1999. 381