Foreign Capital and Economic Growth
Eswar S. Prasad
Cornell University - Dyson School of Applied Economics and Management; Cornell University - Department of Economics; Brookings Institution; NBER; Institute for the Study of Labor (IZA)
Raghuram G. Rajan
University of Chicago - Booth School of Business; International Monetary Fund (IMF); National Bureau of Economic Research (NBER)
International Monetary Fund (IMF); Center for Global Development
IZA Discussion Paper No. 3186
We document the recent phenomenon of uphill flows of capital from nonindustrial to industrial countries and analyze whether this pattern of capital flows has hurt growth in nonindustrial economies that export capital. Surprisingly, we find that there is a positive correlation between current account balances and growth among nonindustrial countries, implying that a reduced reliance on foreign capital is associated with higher growth. This result is weaker when we use panel data rather than cross-sectional averages over long periods of time, but in no case do we find any evidence that an increase in foreign capital inflows directly boosts growth. What explains these results, which are contrary to the predictions of conventional theoretical models? We provide some evidence that even successful developing countries have limited absorptive capacity for foreign resources, either because their financial markets are underdeveloped, or because their economies are prone to overvaluation caused by rapid capital inflows.
Number of Pages in PDF File: 65
Keywords: North-South capital flows, financial globalization
JEL Classification: F3, F4, E2, O4
Date posted: December 4, 2007
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