This paper explores the impact of public investment on private investment in subSaharan Africa using the finite mixture model. We argue that the impact of public investment on private investment differs across groups of countries with similar but unobserved characteristics. Contrary to previous studies, the paper incorporates the potential presence of hidden heterogeneity and tries to explain the group membership. Using a sample of 42 countries, we find that the impact of public investment on private investment differs across three different groups of countries. Moreover, we find that countries with high risk of conflict, terrorism and repatriation of profits are less likely to be in the group where public investment crowds in private investment. The paper underscores the need for sub-Saharan African countries to ensure private investment security by reducing the risks associated with conflicts and terrorism, and preserving contract viability and repatriation of profits.

Introduction

The relationship between public investment and private investment has come under intense controversy in the scientific literature. On the one hand, some authors argue that higher public investment can “crowd out” private investment (Blejer and Khan, 1984; Barro, 1989; Bahmani-Oskooee, 1999). Indeed, for these authors, an increase in public investment can only be achieved either directly by raising taxes on individuals and firms or by increasing the level of indebtedness on the market. Thus, if public investment is financed by higher taxes, this leads to a reduction in aggregate demand and reduces profitability as well as business investment. In contrast, if the government finances public investment by borrowing from banks, it culminates in a raise in interest rates, which consequently affects the cost of capital for the private sector from banks and thereby crowds out (competes away) private investment. On the other hand, Keynesians provide a counterargument that increasing public investment in infrastructure (such as roads, highways and electricity) and/or health and education can have a complementary impact on private investment by increasing the marginal productivity of private capital. They argue that usually budget deficits result in an increase in public investment, which makes private investors become more optimistic about the future course of the economy and invest more (Bahmani-Oskooee, 1999). This suggests a crowdingin effect of public investment on private investment.