The Impact of Capital Flows on Domestic Investment in Transition Economies

34 Pages Posted: 26 Feb 2008

See all articles by Elitza Mileva

Elitza Mileva

European Central Bank; Fordham University - Economics Department

Date Written: February 2008


During the 1990s most transition economies undertook a series of market reforms, including opening their capital accounts. This paper uses static and dynamic panel techniques to assess the effect of FDI, foreign loans and portfolio flows on domestic investment. In this partial adjustment setup, capital flows can have contemporaneous and long-term effects on investment. For countries with less developed financial markets and weaker institutions, our estimates for the FDI coefficient are larger than one, suggesting FDI stimulates investment in other sectors of the economy (spillover effects). Over the longer term, each dollar of FDI generates at least one additional dollar of local investment. In transition countries with stronger governance indicators, long-term loans raise domestic investment and FDI produces small spillover effects in the long run. Limited portfolio flows into the transition economies have no effect on capital formation in either group.

Keywords: Transition economies, capital inflows, domestic investment, international financial integration

JEL Classification: F21, F30, P33

Suggested Citation

Mileva, Elitza, The Impact of Capital Flows on Domestic Investment in Transition Economies (February 2008). ECB Working Paper No. 871, Available at SSRN:

Elitza Mileva (Contact Author)

European Central Bank ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314

Fordham University - Economics Department ( email )

441 East Fordham Road
Bronx, NY 10458
United States

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