Working Paper: NBER ID: w12668
Authors: Jiandong Ju; Shangjin Wei
Abstract: International capital flows from rich to poor countries can be regarded as either too small (the Lucas paradox in a one-sector model) or too large (when compared with the logic of factor price equalization in a two-sector model). To resolve the paradoxes, we introduce a non-neo-classical model which features financial contracts and firm heterogeneity. In our model, free trade in goods does not imply equal returns to capital across countries. In addition, rich patterns of gross capital flows emerge as a function of financial and property rights institutions. A poor country with an inefficient financial system may simultaneously experience an outflow of financial capital but an inflow of FDI, resulting in a small net flow. In comparison, a country with a low capital-to-labor ratio but a high risk of expropriation may experience outflow of financial capital without compensating inflow of FDI.
Keywords: international capital flows; financial contracts; firm heterogeneity
JEL Codes: F0; F2; F3; F36
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial system efficiency (P43) | capital flows (F32) |
| property rights protection (P14) | capital flows (F32) |
| financial development + expropriation risk (O16) | capital flows (F32) |
| inefficient financial systems (P34) | significant outflows of financial capital (F21) |
| low capital-to-labor ratio + high expropriation risk (G31) | outflow of financial capital without compensating inflow of FDI (F21) |
| financial system development (O16) | returns to financial investment (G11) |
| returns to labor (J22) | capital flow dynamics (F32) |