A Solution to Two Paradoxes of International Capital Flow

Jiandong Ju and Shang-Jin Wei

No 06/178, IMF Working Papers from International Monetary Fund

Abstract: International capital flows from rich to poor countries can be regarded as 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). To resolve the paradoxes, we introduce a non-neoclassical model which features financial contracts and firm heterogeneity. In our model, free patterns of gross capital flow 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. A poor country with an inefficient financial system but a low expropriation risk may simultaneously experience an outflow of financial capital but an inflow of foreign direct investment (FDI), resulting in a small net flow.

Keywords: Lucas paradox; factor price equalization; financial development; property rights institutions; and expropriation risk; Capital flows; Economic models; Prices (search for similar items in EconPapers)
Date: 2006-08-04
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Related works:
Working Paper: A Solution to Two Paradoxes of International Capital Flows (2006)
Working Paper: A Solution to Two Paradoxes of International Capital Flows (2006)
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