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The Feldstein-Horioka Puzzle or Paradox after 44 Years: A Fallacy of Composition

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  • Horioka, Charles Yuji

Abstract

The finding of Feldstein and Horioka (1980) that domestic saving and domestic investment are highly correlated across countries despite the rapid globalization and liberalization of financial markets in recent decades has been regarded as a Puzzle or Paradox. However, in this paper, we show that countries as a whole may not be able to transfer their capital abroad and that the Feldstein-Horioka Finding of domestic saving and domestic investment being highly correlated across countries may arise even if there are no frictions in financial markets and even if individual investors can freely transfer their capital abroad if there are frictions in goods markets such as transport costs, tariffs, nontariff barriers, the cost of regulatory compliance, etc. In fact, there is evidence that frictions in goods markets are a more serious impediment to countries as a whole being able to transfer their capital abroad than frictions in financial markets, especially in the short run.

Suggested Citation

  • Horioka, Charles Yuji, 2024. "The Feldstein-Horioka Puzzle or Paradox after 44 Years: A Fallacy of Composition," AGI Working Paper Series 2024-01, Asian Growth Research Institute.
    • Handle: RePEc:agi:wpaper:02000074
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    Keywords

    Capital controls; fallacy of composition; Feldstein-Horioka Finding; Feldstein-Horioka Puzzle or Paradox; frictions in financial markets; frictions in goods markets; global interest rate; globalization and liberalization of financial markets; interest parity; interest rate equalization; international capital flows; international capital mobility; saving-investment correlations; saving retention coefficient; trade costs; trade frictions;
    All these keywords.

    JEL classification:

    • F15 - International Economics - - Trade - - - Economic Integration
    • 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
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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