Economic Takeoff and Capital Flight

Hiroshi Shibuya

ESRI Discussion paper series from Economic and Social Research Institute (ESRI)

Abstract: This paper presents a model of economic takeoff and capital flight with free international capital flows. In the early stage of development, investments are complementary and production exhibits increasing returns to capital. The increasing returns give rise to strategic complementarity between the optimal portfolio decisions of international investors. It produces two stable Nash equilibria: a low and high capital equilibrium. Switches between two equilibria represent economic takeoff and capital flight. At the high capital equilibrium, the interest rate parity with risk premium holds and international capital allocation is efficient. The model identifies the return and risk factors that can trigger switches between two equilibria. The role of government is to achieve the high capital equilibrium through policies that affect the return and risk factors. The globalization of capital markets helps achieve economic takeoff through risk-sharing among the increasing number of investors. The development strategy of domestic capital accumulation and capital market liberalization can achieve economic takeoff. However, a developing country may be trapped in the low capital equilibrium if the liberalization is implemented before a sufficient accumulation of domestic capital.

Pages: 40 pages
Date: 2001-12
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