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Institution-Induced Productivity Differences And Patterns Of International Capital Flows

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  • Kiminori Matsuyama

Abstract

This paper studies theoretically how the cross-country differences in the institutional quality (IQ) of domestic credit markets shape the patterns of international capital flows when such IQ differences also cause productivity differences across countries. IQ affects productivity by changing productivity–agency-cost trade-offs across heterogeneous investment projects. Such institution-induced productivity differences are shown to have effects on the investment and capital flows that are opposite of exogenous productivity differences. This implies that the overall effect of IQ could generate U-shaped responses of the investment and capital flows. Among other things, this means that capital could flow from middle-income countries to both low-income and high-income countries, and that, starting from a very low IQ, a country could experience both a growth and a current account surplus after a successful institutional reform. More generally, the results here provide some cautions when interpreting the empirical evidence on the role of productivity differences and institutional differences on capital flows. It also calls into question the validity of treating the degree of financial frictions as a proxy for the quality of financial institutions, as commonly done in the literature.

Suggested Citation

  • Kiminori Matsuyama, 2014. "Institution-Induced Productivity Differences And Patterns Of International Capital Flows," Journal of the European Economic Association, European Economic Association, vol. 12(1), pages 1-24, February.
  • Handle: RePEc:bla:jeurec:v:12:y:2014:i:1:p:1-24
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    Cited by:

    1. Bjørnskov, Christian & Méon, Pierre-Guillaume, 2015. "The Productivity of Trust," World Development, Elsevier, vol. 70(C), pages 317-331.
    2. Fałkowski, Jan & Curzi, Daniele & Olper, Alessandro, 2016. "Contract (in)completeness, product quality and trade – evidence from the food industry," 2016 Fifth AIEAA Congress, June 16-17, 2016, Bologna, Italy 242321, Italian Association of Agricultural and Applied Economics (AIEAA).

    More about this item

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • F49 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Other
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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