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Financial Development and the Patterns of International Capital Flows

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  • von Hagen, Jürgen
  • Zhang, Haiping

Abstract

We develop a tractable, two-country, overlapping-generations model and show that cross-country differences in financial development can explain three recent empirical patterns of international capital flows: Financial capital flows from relatively poor to relatively rich countries while foreign direct investment flows in the opposite direction; net capital flows go from poor to rich countries; despite its negative net international investment position, the US receives a positive net international investment income. We also explore the welfare and distributional effects of international capital flows and show that the direction of capital flows may change along the convergence process of a developing country. Matsuyama (Econometrica 2004) argues that, in the presence of credit market imperfections, financial market globalization may lead to a steady-state equilibrium in which fundamentally identical countries end up with different levels of per-capita output. We show that this symmetry-breaking property depends crucially on the assumption that investment operates on the extensive rather than the intensive margin.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7690.

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Date of creation: Feb 2010
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Handle: RePEc:cpr:ceprdp:7690

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Related research

Keywords: capital account liberalization; financial development; financial frictions; foreign direct investment; symmetry breaking;

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References

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  1. Devereux, Michael B. & Sutherland, Alan, 2009. "A portfolio model of capital flows to emerging markets," Journal of Development Economics, Elsevier, vol. 89(2), pages 181-193, July.
  2. Kosuke Aoki & Gianluca Benigno & Nobuhiro Kiyotaki, 2010. "Adjusting to Capital Account Liberalization," CEP Discussion Papers dp1014, Centre for Economic Performance, LSE.
  3. Kosuke Aoki & Gianluca Benigno & Nobuhiro Kiyotak, 2007. "Capital flows and asset prices," LSE Research Online Documents on Economics 3168, London School of Economics and Political Science, LSE Library.
    • Kosuke Aoki & Gianluca Benigno & Nobuhiro Kiyotaki, 2009. "Capital Flows and Asset Prices," NBER Chapters, in: NBER International Seminar on Macroeconomics 2007, pages 175-216 National Bureau of Economic Research, Inc.
  4. Richard H. Clarida, 2006. "G7 Current Account Imbalances: Sustainability and Adjustment," NBER Working Papers 12194, National Bureau of Economic Research, Inc.
  5. Matthew Higgins & Thomas Klitgaard & Cédric Tille, 2006. "Borrowing without debt? Understanding the U.S. international investment position," Staff Reports 271, Federal Reserve Bank of New York.
  6. Diego Valderrama & Katherine Smith, 2009. "Why Do Emerging Economies Import Direct Investment and Export Savings? A Story of Financial Underdevelopment," 2009 Meeting Papers 1160, Society for Economic Dynamics.
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Cited by:
  1. Pengfei Wang & Yi Wen & Zhiwei Xu, 2012. "Two-way capital flows and global imbalances: a neoclassical approach," Working Papers 2012-016, Federal Reserve Bank of St. Louis.
  2. von Hagen, Jürgen & Zhang, Haiping, 2014. "Financial development, international capital flows, and aggregate output," Journal of Development Economics, Elsevier, vol. 106(C), pages 66-77.

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