Two‐Way Capital Flows and Global Imbalances

Abstract

This article shows how underdeveloped financial markets in emerging economies can explain the pattern of two-way capital flows between emerging economies (such as China) and the developed world (such as the United States). Our calibrated model reproduces China's rising financial capital outflows and FDI inflows as well as its massive trade imbalances in recent decades. Our model also predicts that global trade imbalances may be sustainable even in the long run and the conventional wisdom that the 'saving glut' of emerging economies is responsible for the global low interest rate may be wrong.

Patterns of international capital flows and their implications for developing countries

“…(Bernanke 2005. ) There is a vast theoretical literature that considers differences in financial development as the main driver of global current account imbalances (see, e.g., Angeletos andPanousi (2011), Benhima (2013b), von Hagen and Zhang (2014) as well as Eugeni (2015) which are closely related to Caballero et al (2008) and/or to Mendoza et al (2009), Ju andWei (2010) as well as Wang et al (2017) which model two-way capital flows, and Coeurdacier et al (2015) which provides microfoundations for the emergence of a global saving glut.) 18 To summarize, these theoretical papers suggest that capital market imperfections and heterogeneity in financial development are central to explaining stylized facts 1, 2 and 6.…”

Born like China, growing like China

“…Wang, Weh, and Xu () point to a “two way capital flow puzzle”: fixed capital flows from rich to poor countries, whereas financial capital flows in the opposite direction. They augment a neoclassical growth model with two wedges: one that distorts firms’ investment decisions and another that distorts households’ saving decisions.…”

“…In addition, Jeanne and Rancière (2011) and Bacchetta, Benhima, and Kalantzis (2013) found that neither the precautionary motive against aggregate shocks nor the presence of idiosyncratic shocks can explain international reserve accumulation in China. Wang, Weh, and Xu (2015) point to a "two way capital flow puzzle": fixed capital flows from rich to poor countries, whereas financial capital flows in the opposite direction. They augment a neoclassical growth model with two wedges: one that distorts firms' investment decisions and another that distorts households' saving decisions.…”

The South's demographic transition and international capital flows in a financially integrated world economy

“…In recent years, most of the literature devoted to financial markets and the allocation of capital has focused on the Lucas (1990) paradox, namely the lack of capital flows from rich to poor countries that are expected to offer higher returns. The observed upstream capital flows and global imbalances, amounting to 0.62% of world GDP on average over the last decade, 4 have led to explanations rooted in differences in public expenditure [Eugeni (2015)], in time preference [Aglietta et al (2002[Aglietta et al ( , 2007], in financial rigidities [Song et al (2011), Reinhardt et al (2013), Coeurdacier et al (2015)], or in asset riskiness (Gourinchas and Jeanne (2013), Alfaro et al (2014), Wang et al (2015)]. Wang et al (2015) suppose a higher risk-free interest rate in developed economies.…”