New insight into Feldstein and Horioka Paradox: Analyzing the mediating roles of globalization, urbanization, and foreign direct investment

• Published date: 01 May 2022
• Author: Seyi S. Akadiri,Martins O. Apinran,Nurudeen Usman
• Date: 01 May 2022
• DOI: http://doi.org/10.1002/pa.2472

ACADEMIC PAPER

New insight into Feldstein and Horioka Paradox: Analyzing

the mediating roles of globalization, urbanization, and foreign

direct investment

Seyi S. Akadiri

1

| Martins O. Apinran

2

| Nurudeen Usman

2

1

Research Department, Central Bank of

Nigeria, Abuja, Nigeria

2

Monetary Policy Department, Central Bank of

Nigeria, Abuja, Nigeria

Correspondence

Seyi S. Akadiri, Research Department, Central

Bank of Nigeria, Abuja, Nigeria.

Email: ssakadiri@cbn.gov.ng

Different dimensions abound to examine the famous Feldstein–Horioka Puzzle.

However, after intense discussions of the subject matter for more than three

decades, researchers are yet to reach consensus on the validity or otherwise of

savings–investment relationship. In this paper, we revisited the Feldstein–Horioka

saving-investment puzzle, and augment their investment equation with factors that

drive capital mobility, such as globalization, foreign direct investment, and urbaniza-

tion using more recent annual frequency time series data over the periods

1981–2018 in the case of Nigeria. We employed unit root test with structural

breaks/regime shifts inherent in time series data and Autoregressive Distributed Lag

Bounds Testing for co-integration of empirical estimates. Results show existence of a

long-run equilibrium relationship among variables. Domestic savings, real income,

and foreign direct investment reveal positive impact, while globalization and urbani-

zation exhibit negative impact on domestic investment both in the short and long

run. We find strong capital mobility among savings–investment relationship, thus

render potential policy suggestions that would drive domestic investment and bring

about sustainable economic growth in the long run.

1|INTRODUCTION

There is a presumption among economists that if financial markets are

liberalized, capital can flow freely from one country to another. The

movement of capital across countries has profuse policy associated

and theoretical outcomes. Should capital move freely across coun-

tries; agents seeking to maximize returns would divert savings from

wherever they occur to where the best investment opportunities

exist. Hence, the level of saving and investment should not be corre-

lated across countries McKinnon (1973) and Shaw (1973).

The theoretical framework for liberalization of financial markets is

based on the Seminal McKinnon–Shaw hypothesis. McKinnon (1973)

and Shaw (1973) opined that under free-market conditions and

removal of capital restrictions, the increase in saving rates and capital

efficiency would increase investments (Gregorio & Guidotti, 1995).

Hence, when capital mobility exists in an economy, domestic invest-

ment's reliance on domestic savings is anticipated to decline. While

capital will move toward countries with higher returns; however, sev-

eral factors hinder the movement of capital from one country to

another: institutional barriers; government regulation; risk perception,

taxes, and transaction costs hinder flows of foreign direct and portfo-

lio investments (Feldstein, 1983a). These limitations on the movement

of capital make domestic savings an important means in the financing

of domestic investments. In a seminal work, Feldstein and Hor-

ioka (1980) examined the relationship between domestic investment

and savings in 16 Organization for Economic Cooperation and Devel-

opment (OECD) countries. They estimated Equation (1) below:

I

Y



i

=α+βS

Y



i

,ð1Þ

where I,S, and Yrepresent the level of investment, savings and output

in country iand αand βdenote constant and the savings retention

coefficient respectively. Feldstein and Horioka (1980) proposed that

Received: 5 August 2020 Revised: 27 August 2020 Accepted: 5 September 2020

DOI: 10.1002/pa.2472

J Public Affairs. 2022;22:e2472. wileyonlinelibrary.com/journal/pa © 2020 John Wiley & Sons Ltd 1of13

https://doi.org/10.1002/pa.2472