A Solution to Two Paradoxes of International Capital Flows
IMF Working Papers, July 1, 2006
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Bibliographic details
- Authors: Shang-Jin Wei, Jiandong Ju
- Published: July 1, 2006
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451864380.001
Core research question and paradoxes
- Examines why international capital flows from rich to poor countries can appear either:
- "too low" — the Lucas paradox in a one-sector model, or
- "too high" — when compared with the logic of factor price equalization in a two-sector model.
- Objective: reconcile these two seemingly contradictory observations within a single theoretical framework.
Model and methodological features
- Introduces a non-neoclassical model that features:
- financial contracts, and
- firm heterogeneity.
- Emphasizes how gross capital flow patterns emerge as a function of:
- the quality of the financial system, and
- the level of protection for property rights (i.e., the risk of expropriation).
Key findings
- Free patterns of gross capital flow are determined by financial-system quality and expropriation risk.
- A poor country with an inefficient financial system but a low expropriation risk may:
- simultaneously experience an outflow of financial capital, and
- experience an inflow of foreign direct investment (FDI),
- resulting in a small net capital flow.
- The model offers a resolution to both the Lucas-paradox view (insufficient capital flowing to poor countries) and the factor-price-equalization view (excessive capital flows implied by two-sector neoclassical models).
Subjects and keywords
- Subject: Capital flows, Foreign direct investment, Self-employment, Trade in goods, Trade liberalization
- Keywords: financial system, interest rate, WP