Feldstein-Horioka Paradox – The Case of South Asian Association for Regional Cooperation

Abstract

Empirically, the positive association between domestic savings and capital formation is well recognized in research works where the extent of contribution of domestic savings to domestic investments varies among the courtiers. Considering both the significance of Feldstein-Horioka Paradox and the gradual rise in global importance for the South Asian nations from political and economic contexts, this research paper has been designed to trace out the impact of domestic savings, foreign aid, dynamism in capital mobility over time and the extent of trade openness on domestic capital formation for the 8 SAARC economies with a view to comment on the status of the Feldstein-Horioka puzzle. We have covered 34 annual observations for the time span 1980-2013 and installed several alternative static linear panel estimation techniques (POLS, FEM, REM) with a slight modification of the specification used by Isaksson (2001). Empirically, apart from foreign aid, all the other regressors have been found to be significant. The results also demonstrate that during the timeframe both gross savings and trade openness have positively affected domestic investments, which is absolutely in line with the previous research works. Moreover, it is also evident that foreign aid hasn’t contributed well in capital accumulation in this region and gradual financial liberalization along with other initiatives has made the global capital more accessible to the economies.

JEL Classification: F21, F30, F35

Keywords: Feldstein-Horioka Paradox, Panel Data, South Asia