Effect of Domestic Savings, Foreign Aid and Direct International Investments on Gross Capital Formation in Kenya

Abstract

Gross capital formation average of 20.13 per cent of GDP over the sub-sample period 2006-2017 for Kenya is low by Sub-Saharan Africa’s standards. It does not meet the target of at least 25 per cent of GDP that is necessary for sustainable growth. The situation has adversely affected the welfare of majority of Kenyans. Therefore, there is urgent need for enhancing gross capital formation in order alleviate people’s suffering. However, policy intervention effort is hampered by the gaps in knowledge about domestic saving-multilateral aid-bilateral aid-foreign direct investment-diaspora remittance-gross capital formation link. The principal objective of this study was to assess the effect of domestic savings, foreign aid and direct international investments on gross capital formation in Kenya. Specifically, the study sought to: examine the effect of domestic saving on gross capital formation in Kenya; assess whether multilateral aid and bilateral aid differently affect gross capital formation in Kenya or not; investigate the effect of foreign direct investment on gross capital formation in Kenya; assess the effect of diaspora remittance on gross capital formation in Kenya. A correlational studies research design was adopted.The study was anchored by Solow’s neoclassical growth model. Autoregressive distributed lag (ARDL) econometric model was specified for long-run effects since the dependent variable was integrated of order (1) while independent variables were either integrated of order (0) or (1) but not (2). Error correction mechanism (ECM) model was specified for short-run effects. Time series data was sourced from the World Bank over period 1974-2017 because of observed surges and downturns in the study’s variables of interest. At 5 percent level of significance, ARDL estimation found domestic saving to be statistically insignificant. The elasticity for multilateral aid was negative (-1.2075) and significant in the short-run and long-run during current year. However, it becomes positive (0.8541) and significant in the long-run a year later. The elasticity for bilateral aid was found to be negative (-0.1005) and significant in the long-run after one year. FDI had a positive elasticity of 0.0617 in the short-run and long-run during the current year and a positive significant elasticity of 0.0460 a year later. The elasticity for diaspora remittance was positive (0.1429) and significant in the long-run after 1 lag. The study concluded that in the short-run, Kenya’s capital formation depends on FDI. But in the long-run, it will rely on multilateral aid, FDI and diaspora remittance. It also concluded that bilateral aid reduces capital formation in Kenya over the long-run horizon. The results are consistent with evidence and passed all validity and reliability tests. Therefore, to achieve sustainable capital formation in the long-runand hence the SDG of creating productive employment and high economic growth in Kenya, the study prescribeda raft of policy measures attract more multilateral aid, FDI and diaspora remittance. Further, policies for enhancing the effectiveness of bilateral aid were proposed for consideration by the Government of Kenya.