Arnab K. Basu () (Department of Economics, College of William and Mary) Nancy H. Chau () (Department of Applied Economics and Management, Cornell University)
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This paper develops a positive theory of two-way capital flows – the simultaneous outward flight of capital assets, and the inflow of foreign direct investment that acquires ownership of local productions units. The basic model exploits insights from entrepreneurial decision making under uncertainty in a general equilibrium setting, and traces out the relationship between (i) entrepreneurial incentives to exploit higher expected profits from risky production activities at the firm level and (ii) the resulting competitive rewards to capital in general equilibrium. The model shows that contrary to expectation, relative liquid assets tend to flow from capital-poor to capital-rich economies, while foreign direct investment aimed at acquiring ownership of production units follows the reversed pattern. We also examine the optimal investment policies for both host and origin countries, and show the rationale behind the inherent conflict of interests between developing and developed economies in the context of capital market liberalization.
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Paper provided by East Asian Bureau of Economic Research in its series Macroeconomics Working Papers with number
160.
Length: 32 pages Date of creation: May 2003 Date of revision: Handle: RePEc:eab:macroe:160
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Find related papers by JEL classification: R13 - Urban, Rural, and Regional Economics - - General Regional Economics - - - General Equilibrium and Welfare Economic Analysis of Regional Economies E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
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