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Foreign Capital and Economic Growth

Author

Listed:
  • Eswar S. Prasad

    (Cornell University)

  • Raghuram G. Rajan

    (University of Chicago)

  • Arvind Subramanian

    (Peterson Institute for International Economics)

Abstract

Nonindustrial countries that have relied more on foreign finance have not grown faster in the long run as standard theoretical models predict. The reason may lie in these countries’ limited ability to absorb foreign capital, especially because their financial systems have difficulty allocating it to productive uses, and because their currencies are prone to appreciation (and often overvaluation) when such inflows occur. The current anomaly of poor countries financing rich countries may not really hurt the former’s growth, at least conditional on their existing institutional and financial structures. Our results do not imply that foreign finance has no role in development or that all types of capital naturally flow “uphill.” Indeed, the patterns associated with foreign direct investment flows have generally been more consistent with theoretical predictions. However, we find no evidence that providing financing in excess of domestic saving is the channel through which financial integration delivers its benefits.

Suggested Citation

  • Eswar S. Prasad & Raghuram G. Rajan & Arvind Subramanian, 2007. "Foreign Capital and Economic Growth," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 38(1), pages 153-230.
  • Handle: RePEc:bin:bpeajo:v:38:y:2007:i:2007-1:p:153-230
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    More about this item

    Keywords

    Foreign capital; economic growth; macroeconomics; foreign finance;

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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