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External Constraints and Endogenous Growth: Why Didn’t Some Countries Benefit from Capital Flows?

Empirical evidence on the growth benefits of capital inflows is mixed. The growth benefits accruing from capital inflows also appear to be larger for high savings countries. We explain this phenomenon using an OLG model of endogenous growth in open economies with borrowing constraints that can generate both positive and negative growth effects of capital inflows. The amount an economy can borrow is restricted by an endogenous enforcement constraint. In our setting, with physical capital and a pay-as-you-go pensions system, the steady state is unique. However, it can either be constrained or unconstrained. In a constrained economy, opening up to equity and FDI inflows can be bad for growth because it makes the domestic interest rate too low, which endogenously tightens borrowing constraints. Agents decrease savings and investment in productivity-enhancing activities resulting in lower growth. Results are reversed in an unconstrained economy. We also provide a quantitative analysis of these constraints and some policy implications.

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Paper provided by Aix-Marseille School of Economics, Marseille, France in its series AMSE Working Papers with number 1329.

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Length: 35 pages
Date of creation: Mar 2013
Date of revision: Mar 2013
Handle: RePEc:aim:wpaimx:1329
Contact details of provider: Web page: http://www.amse-aixmarseille.fr/en

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  1. George-Marios Angeletos & Vasia Panousi, 2011. "Financial Integration, Entrepreneurial Risk and Global Imbalances," NBER Working Papers 16761, National Bureau of Economic Research, Inc.
  2. Carroll, Christopher D. & Jeanne, Olivier, 2009. "A tractable model of precautionary reserves, net foreign assets, or sovereign wealth funds," CFS Working Paper Series 2009/15, Center for Financial Studies (CFS).
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  13. Cristina Arellano & Enrique G. Mendoza, 2002. "Credit Frictions and 'Sudden Stops' in Small Open Economies: An Equilibrium Business Cycle Framework for Emerging Markets Crises," NBER Working Papers 8880, National Bureau of Economic Research, Inc.
  14. Kosuke Aoki & Gianluca Benigno & Nobuhiro Kiyotaki, 2010. "Adjusting to Capital Account Liberalization," CEP Discussion Papers dp1014, Centre for Economic Performance, LSE.
  15. Bulow, J. & Rogoff, K., 1988. "Sovereign Debt: Is To Forgive To Forget?," Papers 411, Stockholm - International Economic Studies.
  16. Vasia Panousi & George-Marios Angeletos, 2010. "Financial integration, entrepreneurial risk and global dynamics," Finance and Economics Discussion Series 2010-54, Board of Governors of the Federal Reserve System (U.S.).
  17. Damiano Sandri, 2014. "Growth and Capital Flows with Risky Entrepreneurship," American Economic Journal: Macroeconomics, American Economic Association, vol. 6(3), pages 102-23, July.
  18. Joshua Aizenman & Vladyslav Sushko, 2011. "Capital Flow Types, External Financing Needs, and Industrial Growth: 99 countries, 1991-2007," NBER Working Papers 17228, National Bureau of Economic Research, Inc.
  19. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
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