Our findings are consistent with the conventional wisdom on the composition of
capital flows. Foreign direct investment has historically played a larger role in
developing countries than have other forms of capital flows. Though some
countries have experienced periods of large bank inflows, they haven’t been
sustained over time. For the countries in our sample, FDI constituted the largest
component of capital flows followed by portfolio flows and bank flows. During
1976–1998 average annual foreign direct investment represented 1.4 per cent of
GDP, and portfolio flows and bank flows were approximately 1.1 and 0.5 per cent
of GDP. Similarly, simple measures of volatility indicate that FDI was the most
stable form of capital flows, while bank flows were the most volatile. For instance,
the coefficient of variation of annual FDI, portfolio and banks flows to our sample
countries during 1976–1998 was 1.2, 2.8 and 4.8 per cent respectively. Given that
bank flows have been small and volatile, it is likely that they have not made a
meaningful contribution to investment. Our results also suggest that portfolio flows
affect growth above and beyond their effect on investment. While the identification
of the exact channels is beyond the scope of this paper, the most likely channel
(besides investment) through which foreign investment in the domestic equity and
debt markets could contribute to growth is through the development and deepening
of these markets.