The Micro and Macro Dynamics of Capital Flows

Working Paper: CEPR ID: DP14893

Authors: Felipe Saffie; Liliana Varela; Keimu Yi

Abstract: We study empirically and theoretically the effects of international capital flows on resource allocation. Using the universe of firms in Hungary, we show that financial openness triggers input-cost and consumption channels, with the latter dominant and reallocating resources toward high expenditure elasticity activities in the short run. A multi-sector heterogeneous firm trade model replicates these dynamics. In the long-run, the model predicts that resources will shift towards manufacturing exports to service debt. Owing to endogenous terms of trade dynamics, countries face a trade-off between the speed of convergence and their long-run capital stock; thus, financial openness can lead to welfare losses.

Keywords: firm dynamics; financial liberalization; reallocation; capital flows; welfare; non-homothetic preferences

JEL Codes: F15; F41; F30; F43; F63

Causal Claims

Cause	Effect
financial openness (F30)	input cost channel (C67)
financial openness (F30)	consumption channel (D10)
input cost channel (C67)	reallocation of resources towards high expenditure elasticity activities (E20)
consumption channel (D10)	reallocation of resources towards high expenditure elasticity activities (E20)
capital inflows (F21)	relative price of capital (D33)
capital inflows (F21)	current consumption (E20)
25th percentile to 75th percentile of capital elasticity (D24)	35% increase in value added (O49)
25th percentile to 75th percentile of capital elasticity (D24)	5% increase in capital (G31)
25th percentile to 75th percentile of expenditure elasticity (D12)	4% increase in value added (O49)
long run necessity for increased exports (F10)	shift resources back towards manufacturing (O14)
short-term reallocation towards services (J68)	trade-off between speed of economic convergence and long-term capital stock (F62)