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A Solution to Two Paradoxes of International Capital Flows

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Author Info
Ju, Jiandong
Wei, Shang-Jin

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Abstract

International capital flows from rich to poor countries can be regarded as either too small (the Lucas paradox in a one-sector model) or too large (when compared with the logic of factor price equalization in a two-sector model). To resolve the paradoxes, we introduce a non-neo-classical model which features financial contracts and firm heterogeneity. In our model, free trade in goods does not imply equal returns to capital across countries. In addition, rich patterns of gross capital flows emerge as a function of financial and property rights institutions. A poor country with an inefficient financial system may simultaneously experience an outflow of financial capital but an inflow of FDI, resulting in a small net flow. In comparison, a country with a low capital-to-labor ratio but a high risk of expropriation may experience outflow of financial capital without compensating inflow of FDI.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5981.

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Date of creation: Dec 2006
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Handle: RePEc:cpr:ceprdp:5981

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Related research
Keywords: capital bypass circulation expropriation risk financial development gross capital flow heterogeneous entrepreneurs

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Find related papers by JEL classification:
F11 - International Economics - - Trade - - - Neoclassical Models of Trade
F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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References listed on IDEAS
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  2. Rene M. Stulz, 2005. "The Limits of Financial Globalization," NBER Working Papers 11070, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Carmen M. Reinhart & Kenneth S. Rogoff, 2004. "Serial Default and the "Paradox" of Rich to Poor Capital Flows," NBER Working Papers 10296, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Jose Wynne, 2005. "Wealth as a Determinant of Comparative Advantage," American Economic Review, American Economic Association, vol. 95(1), pages 226-254, March. [Downloadable!] (restricted)
  5. Stulz, Rene M., 2005. "The Limits of Financial Globalization," Working Paper Series 2005-1, Ohio State University, Charles A. Dice Center for Research in Financial Economics. [Downloadable!]
  6. Shleifer, Andrei & Wolfenzon, Daniel, 2002. "Investor protection and equity markets," Journal of Financial Economics, Elsevier, vol. 66(1), pages 3-27, October. [Downloadable!] (restricted)
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  7. Daron Acemoglu & Simon Johnson & James A. Robinson, 2001. "The Colonial Origins of Comparative Development: An Empirical Investigation," American Economic Review, American Economic Association, vol. 91(5), pages 1369-1401, December. [Downloadable!] (restricted)
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  8. Ronald W. Jones, 1965. "The Structure of Simple General Equilibrium Models," Journal of Political Economy, University of Chicago Press, vol. 73, pages 557. [Downloadable!] (restricted)
  9. Shang-Jin Wei, 2000. "Local Corruption and Global Capital Flows," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 31(2000-2), pages 303-354. [Downloadable!]
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  11. Xiang, Chong, 2001. "The sufficiency of the 'lens condition' for factor price equalization in the case of two factors," Journal of International Economics, Elsevier, vol. 53(2), pages 463-474, April. [Downloadable!] (restricted)
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  1. Marcel Fratzscher & Luciana Juvenal & Lucio Sarno, 2007. "Asset prices, exchange rates and the current account," Working Paper Series 790, European Central Bank. [Downloadable!]
    Other versions:
  2. Kiminori Matsuyama, 2007. "Aggregate Implications of Credit Market Imperfections," NBER Working Papers 13209, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Joseph W. Gruber & Steven B. Kamin, 2008. "Do differences in financial development explain the global pattern of current account imbalances?," International Finance Discussion Papers 923, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  4. Frankel, Jeffrey, 2006. "Global Imbalances and Low Interest Rates: An Equilibrium Model vs. A Disequilibrium Reality," Working Paper Series rwp06-035, Harvard University, John F. Kennedy School of Government. [Downloadable!]
  5. Fratzscher, Marcel & Imbs, Jean, 2007. "Risk Sharing, Finance and Institutions in International Portfolios," CEPR Discussion Papers 6496, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  6. Eswar Prasad & Raghuram G. Rajan & Arvind Subramanian, 2006. "Patterns of international capital flows and their implications for economic development," Proceedings, Federal Reserve Bank of Kansas City, pages 119-158. [Downloadable!]
  7. Lane, Philip R. & Schmukler, Sergio L., 2007. "The international financial integration of China and India," Policy Research Working Paper Series 4132, The World Bank. [Downloadable!]
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  8. Ricardo J Caballero & Emmanuel Farhi & Pierre-Olivier Gourinchas, 2006. "An equilibrum model of "global imbalances" and low interest rates," BIS Working Papers 222, Bank for International Settlements. [Downloadable!]
    Other versions:
  9. Ju, Jiandong & Wei, Shang-Jin, 2007. "Domestic Institutions and the Bypass Effect of Financial Globalization," CEPR Discussion Papers 6343, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  10. Herrmann, Sabine & Winkler, Adalbert, 2008. "Financial markets and the current account – emerging Europe versus emerging Asia," Discussion Paper Series 1: Economic Studies 2008,05, Deutsche Bundesbank, Research Centre. [Downloadable!]
  11. Henry, Peter B., 2007. "Capital Account Liberalization: Theory, Evidence, and Speculation," Research Papers 1974, Stanford University, Graduate School of Business. [Downloadable!]
  12. Hausmann, Ricardo & Sturzenegger, Federico, 2006. "Global Imbalances or Bad Accounting? The Missing Dark Matter in the Wealth of Nations," Working Paper Series rwp06-003, Harvard University, John F. Kennedy School of Government. [Downloadable!]
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