An exploration of the long-run relationship between saving and investment in the developing economies: a tale of Latin American countries

In this paper we tested the Feldstein-Horioka hypothesis of saving-investment equality using the cointegration methodology. First, we tested for unit roots. We found that, except for Dominican Republic, saving and investment ratios of other nine countries have unit roots. Tests show that both variables are I(1) for these nine countries. We proceed with the cointegration tests using the Johansen-Juselius framework. We use the finite sample correction to adjust our test statistics. The results show that saving and investment ratios have a long-run relationship for only four out often countries. For all four countries, we find that the number of cointegrating vectors is equal to one. The vectors show that there is a long-run positive equilibrium relationship between the two variables. We normalize the vectors with respect to the saving rate and find that the magnitude of the investment coefficients is fairly close to one. For the five other countries, the divergence between saving rate and investment rate may result in macroeconomic instability in the long run.