more expensive and suggest sluggish investment growth will continue (Kose and Ohnsorge 2023).

Against this backdrop, this paper investigates the question of whether public investment, as a fiscal policy tool, can crowd-in private investment. We utilize data from a large panel of 109 EMDEs and employ an instrumental variable approach to identify the relationship between these two types of investment. The empirical setting is guided by a tractable model, where we show that the complementarity (substitutability) between public and private investment is sufficient to crowd-in (-out) private investment. Consequently, the parameter of interest we estimate captures, simultaneously, the structural relationship between public and private investment and the crowding-in (-out) of private investment by public investment. We extend the analysis to low-income countries (LICs) and Sub-Saharan Africa (SSA), two subgroups of countries where infrastructure needs are large given low levels of development and growing populations. Furthermore, we examine whether the effect of public investment on private investment varies by the level of corruption and financial development to understand the potential implications of factors that may impede or enhance the effectiveness of public investment in crowding-in private investment.

The relevance of public investment to spur private investment in EMDEs is critical. Yet, systematic evidence of the crowding-in effect of public investment on private investment in EMDEs remains scarce. The existing literature has focused on a limited number of lowincome countries (Eden and Kraay 2014), high-income OECD countries (Boehm 2020) or U.S states, European countries, and Argentine provinces (Izquierdo et al. 2019). Expanding this to a large set of EMDEs will provide systematic and stronger evidence of the crowding-in effect of private investment in these countries, which can help drive policy strategies to address the weak outlook for investment growth.

Importantly, the existing literature studies the implication of the crowding-in effect of public investment under perfect capital markets. Capital market imperfections and distortions are, however, ubiquitous in developing countries. For example, access to financial markets, which is important for the growth of businesses and investment, is still a challenge in LICs and SSA. Moreover, structural conditions such as weak corruption control, asymmetric information, inaccessibility to financial markets, and market distortions induced by poorly designed tax systems can create imperfect capital markets that discourage private sector investment. Governments also tend to face lower interest rates than private agents (Eden and Kraay 2014). If public investment can crowd-in private investment, then governments can take advantage of the low interest rate they face relative to the private sector to help address underinvestment by the private sector.

In this paper, we move away from the assumption of perfect capital markets. In particular, because of the law of diminishing marginal returns on capital, more public investment may not always be desirable even if it crowds-in private investment. However, if capital market distortions exist (for example, distortionary taxes on firms’ output), this can potentially 3