Investment Slowdown in Developing Countries During the 1980s: Debt Overhang or Foreign Capital Inflows?

This paper estimates a simultaneous-equation model for the determination of creditworthiness and investment rates in developing countries. Its purpose is to test the debt overhang hypothesis, according to which the external debt burden provides a strong disincentive to domestic capital formation. The results indicate that debt overhang has contributed significantly to the reduction in developing country investment rates during 1980-86. The model also examines the contribution of foreign capital inflows and shows that commercial inflows contributed significantly to the investment slowdown, while noncommercial inflows were insignificant. Copyright 1992 by WWZ and Helbing & Lichtenhahn Verlag AG