The interaction effect of foreign capital inflows and financial development on economic welfare in sub-Saharan Africa

Abstract

This study examines the interaction effects of foreign capital inflows and financial development on economic welfare in sub-Saharan Africa (SSA). Estimates based on the system-GMM estimator using panel data on 23 SSA countries for 2000 to 2013 establish several results. First, the interaction between foreign capital inflows and financial development positively affects economic welfare in SSA. However, this effect was negative after one year. Second, the partial indirect effects of foreign capital inflows on economic welfare, conditional on the level of financial development, are positive, though they become negative after one year. Third, the total effect of foreign capital inflows on economic welfare is positive. The effect becomes negative after a year, though the predominant source of financial development is domestic credit. The consistency of these results indicates the importance of financial development in transmitting foreign capital to economic welfare enhancement. Developing the SSA's financial sector to meet specific welfare-enhancing demands may potentially convert a large share of capital inflows into improved economic welfare and eliminate the negative effects.

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“…where H is a vector of health outcomes per capita; Y is a vector of economic variables per capita; S is vector of social variables per capita; E is vector of environmental variables; and D is a vector of health service utilization variables. The scalar form of Equation [2] can be given as in Equation [3]. [3] can be transformed in an explicit form by formulating probability density for the y, s, e and d variables as given in Equation [4].…”

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