Crowding-Out Effect Of Public Investment On Private Investment: An Empirical Investigation

Abstract

This study’s principal objective is to analyze the behavior of private investments in market economies in the New Emerging Economies (transition economies) in Eastern Europe. The main objective is to investigate the effect of public investment on private investments. Borrowing from neoclassical economics authors one expects to see a crowding out effect of public investment on private investments.  The literature is divided and mixed at best at answering the question of what is the role of public investment in private investments. Our preliminary results show that while it can be true that there is a crowding out effect on private investment from public investments in the West, this is not the case looking at the East.  There is a vast discussion on the effect of public investment on private investment at the firm level as well as aggregated at the country level. Among other factors recognized for such a discussion like uncertainty, imperfect competition, effectiveness, cost of capital that can bust or hinder private investment under the normal course of the country’s economy this study looks at another angle. Western countries are diverse in terms of the size of government. The new emerging market economies on the East are struggling to get their economies to compete with western countries which have inherited better public institutions, infrastructure, and market conditions overall.  A pool of selected countries, unbalanced panel data analysis, in Eastern European continent is examined over a period of time 1991-2009. The data are obtained from World Development Indicators (World Bank data base, 2010). Using pooled cross sectional analysis, the data confirm the structural break of private investment behavior between developing and developed countries. This is due to lack of market economy institutions, infrastructure, performance of the economy, and expectations.