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

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  • Karine Gente
  • Miguel A. León-Ledesma
  • Carine Nourry

Abstract

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.

Suggested Citation

  • Karine Gente & Miguel A. León-Ledesma & Carine Nourry, 2013. "External Constraints and Endogenous Growth: Why Didn’t Some Countries Benefit From Capital Flows?," Studies in Economics 1304, School of Economics, University of Kent.
  • Handle: RePEc:ukc:ukcedp:1304
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    2. Faria, João Ricardo & McAdam, Peter, 2015. "Macroeconomic adjustment under regime change: From social contract to Arab Spring," Journal of International Money and Finance, Elsevier, vol. 56(C), pages 1-22.
    3. Peter McAdam & Kostas Mouratidis & Theodore Panagiotidis & Georgios Papapanagiotou, 2023. "European Trade & Growth Imbalances: An Analysis using a Sign-Restriction Bayesian-GVAR with Stochastic Volatility," Working Paper series 23-12, Rimini Centre for Economic Analysis.
    4. Destrée, Nicolas & Gente, Karine & Nourry, Carine, 2021. "Migration, remittances and accumulation of human capital with endogenous debt constraints," Mathematical Social Sciences, Elsevier, vol. 112(C), pages 38-60.
    5. Pan, Xuefeng & Wu, Weixing, 2022. "Can capital inflows reduce financing costs in emerging economies? Firm-level evidence from China and Malaysia," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 77(C).

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    More about this item

    Keywords

    overlapping generations; endogenous credit constraint; capital flows; endogenous growth;
    All these keywords.

    JEL classification:

    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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