Bad Investments and Missed Opportunities? Postwar Capital Flows to Asia and Latin America

Since 1950, the economies of East Asia grew rapidly but received little international capital, while Latin America received considerable international capital even as their economies stagnated. The literature typically explains the failure of capital to flow to high growth regions as resulting from international capital market imperfections. This paper proposes a broader thesis that country-specific distortions, such as domestic labor and capital market distortions, also impact capital flows. We develop a DSGE model of Asia, Latin America, and the Rest of the World that features an open-economy business cycle accounting framework to measure these domestic and international distortions, and to quantify their contributions to international capital flows. We find that domestic distortions have been the predominant drivers of international capital flows, and that the general equilibrium effects of these distortions are very large. International capital market distortions also matter, but less so.