DDP 727. Malcolm F. McPherson and Tzvetana Rakovski. "Financial Deepening and Investment in Africa: Evidence from Botswana and Mauritius." October 1999. 16 pp. CAER Project Paper

This paper tests an hypothesis proposed by Ronald McKinnon regarding the complementarity of real money demand and real investment in economies with fragmented financial systems. The data used are taken from Mauritius and Botswana. Both single equation and systems estimates are used in the analysis. The results provide strong support for the hypothesis in the case of Mauritius. For Botswana, the complementarity has been between real money demand and real savings. This reflects the pattern and financing of investment in Botswana where the resource base was so potentially rich that the necessary resources were provided from abroad during the initial stages of mine development.

For policy purposes, the basic lesson is that mutual dependence between money demand and investment implies that financial development complements economic growth. To stimulate economic growth, policy makers need to focus on measures that promote financial development. One of these, government self-restraint in the use of the economic surplus, has been a major feature of the economic success of both Botswana and Mauritius.

Keywords: Financial development, Investment, Money balances

JEL Classification Codes: E2, E5, O1

Research for this work was sponsored by the Office of Emerging Markets, Economic Growth and Agricultural Development Center, Bureau for Global Programs, Field Support and Research, United States Agency for International Development under the Consulting Assistance on Economic Reform (CAER) II Project, contract PCE-C-00-95-00015-00. The views and interpretations are those of the authors and should not be attributed to USAID.

Malcolm McPherson, Fellow of HIID, is Principal Investigator of the study “Promoting and Sustaining Trade and Exchange Rate Reform in Africa” being conducted under the USAID-financed Equity and Growth in Africa through Economic Research/Trade Regimes and Growth. He is also Principal Investigator of the study “Restarting and Sustaining Growth and Development in Africa” being conducted under the EAGER/Public Strategies for Growth with Equity project.

Tzvetana S. Rakovski is working as a research assistant on the Equity and Growth through Economic Research (EAGER) Project at Harvard Institute for International Development. She holds an M.A. degree in Economics from Northeastern University, Boston and a M.Sc. degree in Mathematics from Sofia University, Bulgaria. Her research interests are in the fields of International Development and Applied Econometrics. Her prior working experience includes a position as a researcher at the Agency for Economic Analysis and Forecasting (AEAF), Sofia, Bulgaria.