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Volume :13 Issue : 49 1987      Add To Cart                                                                    Download

SOURCES OF INVESTMENT FINANCE IN YEMEN ARAB REPUBLIC (YAR): AN APPLICATION OF THE TWO – GAP MODEL

Auther : By: Dr. Osman M. Osman

 

           The question of sources of financing higher investment rates lies at the core of development policy and plans.  Distinction has always been made between domestic and external sources of development finance.  This can be reflected formally in expressing economic growth as being limited by two factors: domestic savings and foreign savings.

           The relative importance of these two factors can be derived from the overall balance of savings investment.  Total resources are the sum of domestic resources (GDP) and resources from abroad that finance the difference between imports and exports.  In the case of Yemen, a very important component of the later has been the workers’ remittances.  Thus, the fundamental saving – investment balance can be formulated as:

 Investment  =       Domestic savings + Net Remittances +

Net Foreign Savings (current account deficit in the balance of payments).

           The external financial position of YAR has changed dramatically in the last two decades.  While at the beginning of the 1970’s foreign exchange was in short supply, the country entered a phase of comfortable balance of payments surpluses.  Thus, has been attributed to the influx of large remittances and foreign assistance.  Remittances covered 90% of the domestic resources gap during the years of the first development plan.  Current account deficit represents only 5% of GDP.  The situation leads to the simple conclusion that foreign exchange was not the limiting factor to domestic investment.  However, national savings, which increased in the 1970’s to more than one-third of GDP, declined in recent years to less than 12%.

           This leads us to the main question of this paper: which of these two factors was the binding constraint on investment in the past?  The paper relies upon the application of the widely used econometric solution of the two –gap model.  The important economic background of this model is that when the economy is constrained by the foreign exchange – gap, the level of national income generated is determined by this gap no matter how high domestic savings may be.  On the other hand, when the savings – gap is the effective constraint the growth rate of national income is determined by this gap no matter how high the inflow of foreign exchange may be.

           Of course, the economic policy to be applied differs substantially according to the kind of gap determining the rate of investment; therefore it is of vital importance to determine the king of constraint to economic growth.

           Calculations have used time series of the different macro-economic variables of the Yemeni economy to apply the two – gap model and test whether domestic savings or foreign exchange has constrained the rate of investment.  The data for the period 1970/71-1983 shows that the foreign exchange gap was the dominant constraint to the pace of capital formation effort in Yemen, thus contradicting the quick an artificial look to the Yemeni economy.  This of course means that economic policy must be directed towards mobilizing more foreign exchange resources for investments.

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