Literature Review on "Role of Private Investment on Economic Development in Iraq"

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3.2. Finance and investment

The major characteristics of developing countries are their poor developments in financial market leading to short-term local currency financing. The market further has few players, which lowers competition, reducing the total received yields and increasing the transaction rates (Platz, 2009). Concurrently, the economic theory states that there is a high relationship between investment and the development in financial status. It commonly occurs when financing SMEs together with large-scale investment projects because they highly rely on developed financial. This implies that any form of increment within the financial intermediation, will lower the financial costs applied in investments and increases the investments and such incidence increases the financial needs. This enabled Huang (2006), to conduct a research on the causality that commonly occurs between the aggregate private investment and the financial development within the globalized world. The research used a panel data that 43 developing countries developed in 1970-1998, ensuring that the analysis occurred in two different stages. The initial stage used data collected in five years and the results showed a positive causal effect in both directions and high levels of persistence in the data between the developments in financial and the private investment. The second step used data collected in a year and it resulted into adaptation of interdependence and heterogeneity among the involved countries.

According to the analysis, there is the incorporation of the private investment and financial development, which leads to positive causal effects within the co-integrated system. Stiglitz & Weiss (1994), contends that during the micro level, many firms encounter financial problems making them to seek control on either their interest rates or credit rationing. The lenders within the financial markets encounter difficulties in differentiating between the good and bad borrowers due to varying factors. These factors entail the asymmetric information, adverse selection and incentive effects among others. Consequently, this makes the creditors to decide on rationing the credit volume during the allocation of credit in firms.

Despite the differences in the model, this literature focuses on the fact that investments might have greater impacts on the financial factors. Dissimilar studies conducted in the field are good evidence because some researchers tested the financial variables together with different roles that that they play in various models and they obtained positive results (Fazzarii, Hubbard & Patersen, 1988). According to the research, the effects of investment on financial factors differ depending on the policies that firms have regarding their retained profits. The recent review by Hassett & Hubbard (1999) indicated that there is enough evidence to support the claim on the roles that financial factors play in the decisions regarding investments. Concurrently, this is also evidence in the many economics and finance researches.

3.3. Private investment and macroeconomic policies applicable in developing countries

There have been different studies in developed countries regarding their investments, which contradict those in developing countries because such studies are limited. This is because developing countries have not shown much interest in conducting researches in the sector. The few existing studies on investment in developing countries are poor because they employ traditional models including the neoclassical and endogenous. The inconveniences are also common because some of the studies rely on equation with varying variables, which they think that are beneficial to the investment activities. Researchers should consider increasing the rate at which they conduct such researches in the developing countries.

3.3.1. Impacts of Monetary and Credit policies on private activities

There are different factors that affect private activities, with the major ones being stability in prices and inflation. To attain the aims, it is imperative to focus on monetarism even though inflation is a monetary phenomenon. With fixed exchange rates, much money supply leads to balance in payments because they lower the cost of imports while increasing those of exports. Capital flight can play a significant role in handling the issue of balance of payment. Different factors such as restrictive monetary policy and low supply of money are capable of lowering inflation, eliminating the balance of payment leading to stability required in the allocation of resources (Croce & Khan, 2000).

Monetary and credit policies have many impacts that affects the private investments together with their long and short-term performances. This makes the policies to be imperative element that determines the private investments. There have been different studies on the effect of those policies on private investments. According to De Melo&Tybout (1986), these studies show that restrictive monetary and credit policies have an impact on bank credit, which affects per capita user cost and these reduces the activities within the private investment. Concurrently, the same research revealed that increase in interest rates reduces private investments because it increases the opportunity cost involved in the internal funds. Furthermore, different researchers (Blejer & Khan, 1984; Lim, 1987; Dailami (Dailami & Walton, 1989)(1990) (Larrain & Vergara, 1993)Vergara (1993) insists that financial markets plays a significant role in understanding the ways in which monetary and credit policies affect the investment and the reasons to why the situation is common among the developing countries. The researchers claim that the effects of credit policy on investment are higher than interest rates. This is because the credit allocation mechanism has high level of access to borrowing at any given interest rates depending with the firms. It is further evident that credit has a positive impact on private investment

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(Atukeren, 2005; Bouton & Mariusz, 2000; Chee-Keong, Zulkornain & Siong-Hook, 2010)

Remarkably, there has been much research on decisions that lenders and banks make, which are important in determining the relationship between credit policies and the economy in the country. Consequently, the studies supported the joint effects of interest rates and credit channels. The results from the different studies have also indicated that increase in interest rates lowers the level of lending in banks, because the banks will have the major responsibility of adjusting their asset portfolio

Dailami&Giugale used the firm investment model to bring out the relationship between credit policy and private investment. The model connects the credit ceiling and the net in the firm together with the state of the credit market that the bank puts in consideration before deciding on their lending decisions. Some of the factors that banks consider include the sentiments, supervisory practices, credit policy and the levels if interest rates among others. This implies that during tight monetary policies companies interested in acquiring loans undergo strict evaluations. This might lead to the postponement or ignoring of the investment plans in a firm. Furthermore, the researchers apply the same model in creating an empirical equation, which draws attention on the real and aggregate credit and their results indicate that interest rates and volume of credit have a significant impact on the activities of private investments.

Additionally, Shrestha&Chowdhury (2005) supported the same views by claiming that credit constraints found in developing capital markets together with inadequate financial intermediation affects the decisions that firms make regarding their investments in a negative way. Inadequate long-term financing and future market makes the bank loans and other external borrowing to be the only borrowing sectors private sectors can use to invest their finances (Khan & Khan, 2007). On the contrary, Huang (2006) claimed that there is appositive relationship between financial development and private investments. This is because the researcher believed that financial development will increase the total opportunities and incentives to the investors while within developed financial sectors, the mobilization and distribution of the resources will be effective for investors.

3.3.2. The effects of fiscal policy on the private investment

The effects of fiscal policy on private investment act through three different channels, which entail the following.… READ MORE