IDEAS home Printed from https://ideas.repec.org/a/red/issued/v7y2004i3p586-612.html
   My bibliography  Save this article

Intermediation Costs and Capital Flows

Author

Listed:
  • Ayse Imrohoroglu

    (University of Southern California)

  • Krishna B. Kumar

    (University of Southern California)

Abstract

In this paper, we modify the standard neoclassical model by incorporating financial intermediation in order to deliver returns consistent with the observation that capital primarily flows to middle income countries. We build a static contracting framework where costly intermediation together with an adverse selection problem have quantitatively important effects on capital flows. When intermediation costs are ignored, the model behaves like the neoclassical model in terms of capital returns. However, when intermediation costs are considered, returns to capital in middle income countries could exceed those in poor and rich countries high costs of intermediation cause poor countries to concentrate their investments in projects with low returns, while the standard neoclassical effect lowers returns in capital-rich countries. When we embed the return function from the static analysis in a two-country dynamic model, there is capital outflow from a poor country that removes capital controls and becomes open. Even though the closed economy dominates in terms of capital employed in production, it is the open economy that dominates in terms of income, consumption and welfare. (Copyright: Elsevier)

Suggested Citation

  • Ayse Imrohoroglu & Krishna B. Kumar, 2004. "Intermediation Costs and Capital Flows," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(3), pages 586-612, July.
  • Handle: RePEc:red:issued:v:7:y:2004:i:3:p:586-612
    DOI: 10.1016/j.red.2003.10.002
    as

    Download full text from publisher

    File URL: http://dx.doi.org/10.1016/j.red.2003.10.002
    File Function: Full text
    Download Restriction: Access to full texts is restricted to ScienceDirect subscribers and ScienceDirect institutional members. See http://www.sciencedirect.com/ for details.

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Simeon Djankov & Rafael La Porta & Florencio Lopez-de-Silanes & Andrei Shleifer, 2002. "The Regulation of Entry," The Quarterly Journal of Economics, Oxford University Press, vol. 117(1), pages 1-37.
    2. Eduardo Fernández-Arias & Ricardo Hausmann, 2000. "Is FDI a Safer Form of Financing?," IDB Publications (Working Papers) 1318, Inter-American Development Bank.
    3. Greenwood, Jeremy & Jovanovic, Boyan, 1990. "Financial Development, Growth, and the Distribution of Income," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages 1076-1107, October.
    4. Aart Kraay & Norman Loayza & Luis Servén & Jaume Ventura, 2005. "Country Portfolios," Journal of the European Economic Association, MIT Press, vol. 3(4), pages 914-945, June.
    5. Lucas, Robert E, Jr, 1990. "Why Doesn't Capital Flow from Rich to Poor Countries?," American Economic Review, American Economic Association, vol. 80(2), pages 92-96, May.
    6. repec:idb:wpaper:416 is not listed on IDEAS
    7. Ross Levine & Norman Loayza & Thorsten Beck, 2002. "Financial Intermediation and Growth: Causality and Causes," Central Banking, Analysis, and Economic Policies Book Series,in: Leonardo Hernández & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Se (ed.), Banking, Financial Integration, and International Crises, edition 1, volume 3, chapter 2, pages 031-084 Central Bank of Chile.
    8. Andres Erosa, 2001. "Financial Intermediation and Occupational Choice in Development," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(2), pages 303-334, April.
    9. Douglas Gollin, 2002. "Getting Income Shares Right," Journal of Political Economy, University of Chicago Press, vol. 110(2), pages 458-474, April.
    10. Prescott, Edward C, 1998. "Needed: A Theory of Total Factor Productivity," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(3), pages 525-551, August.
    11. repec:cup:macdyn:v:7:y:2003:i:4:p:586-617 is not listed on IDEAS
    12. Boyd, John H. & Smith, Bruce D., 1997. "Capital Market Imperfections, International Credit Markets, and Nonconvergence," Journal of Economic Theory, Elsevier, vol. 73(2), pages 335-364, April.
    13. Kumar, Krishna B., 2003. "Education And Technology Adoption In A Small Open Economy: Theory And Evidence," Macroeconomic Dynamics, Cambridge University Press, vol. 7(04), pages 586-617, September.
    14. Martin Neil Baily & Robert M. Solow, 2001. "International Productivity Comparisons Built from the Firm Level," Journal of Economic Perspectives, American Economic Association, vol. 15(3), pages 151-172, Summer.
    15. Restuccia, Diego & Urrutia, Carlos, 2001. "Relative prices and investment rates," Journal of Monetary Economics, Elsevier, vol. 47(1), pages 93-121, February.
    16. Chang-Tai Hsieh & Peter J. Klenow, 2007. "Relative Prices and Relative Prosperity," American Economic Review, American Economic Association, vol. 97(3), pages 562-585, June.
    17. Beck, Thorsten & Demirguc-Kunt, Asli & Levine, Ross, 1999. "A new database on financial development and structure," Policy Research Working Paper Series 2146, The World Bank.
    18. Harm Zebregs, 1998. "Can the Neoclassical Model Explain the Distribution of Foreign Direct Investment Across Developing Countries?," IMF Working Papers 98/139, International Monetary Fund.
    19. Peter Klenow & Andrés Rodríguez-Clare, 1997. "The Neoclassical Revival in Growth Economics: Has It Gone Too Far?," NBER Chapters,in: NBER Macroeconomics Annual 1997, Volume 12, pages 73-114 National Bureau of Economic Research, Inc.
    20. Barro, Robert J & Lee, Jong Wha, 1996. "International Measures of Schooling Years and Schooling Quality," American Economic Review, American Economic Association, vol. 86(2), pages 218-223, May.
    21. Lucas, Robert Jr., 1988. "On the mechanics of economic development," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 3-42, July.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Areendam Chanda & Laura Alfaro & Sebnem Kalemli-Ozcan & Selin Sayek, 2006. "How Does Foreign Direct Investment Promote Economic Growth? Exploring the Effects of Financial Markets on Linkages," Departmental Working Papers 2006-13, Department of Economics, Louisiana State University.
    2. Fidel Pérez Sebastián & Lilia Maliar & Serguei Maliar, 2005. "Sovereign Risk, Fdi Spillovers, And Economic Growth," Working Papers. Serie AD 2005-27, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
    3. Sapci, Ayse, 2017. "Costly financial intermediation and excess consumption volatility," Journal of Macroeconomics, Elsevier, vol. 51(C), pages 97-114.
    4. Silva, André C., 2010. "Managerial ability and capital flows," Journal of Development Economics, Elsevier, vol. 93(1), pages 126-136, September.
    5. Lilia Maliar & Serguei Maliar & Fidel Pérez Sebastián, 2008. "Sovereign Risk, FDI Spillovers, and Growth," Review of International Economics, Wiley Blackwell, vol. 16(3), pages 463-477, August.
    6. Meza, Felipe & Benjamin, David, 2006. "Productivity in economies with financial frictions: facts and a theory," Discussion Paper Series In Economics And Econometrics 0613, Economics Division, School of Social Sciences, University of Southampton.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:red:issued:v:7:y:2004:i:3:p:586-612. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann). General contact details of provider: http://edirc.repec.org/data/sedddea.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.