Growth and Capital Flows with Risky Entrepreneurship
28 Pages Posted: 30 Jul 2009 Last revised: 19 Dec 2009
Date Written: January 11, 2009
Contrary to the prediction of benchmark neoclassical models, growth accelerations in developing countries tend to be associated with current account improvements, resulting from larger increases in saving than in investment. I argue that this can be driven by the behavior of entrepreneurs facing incomplete financial markets and risky investment. The uninsurable risk of losing invested capital forces entrepreneurs to rely on self-financing to build up their firms. As new business opportunities open up, entrepreneurs increase their saving to finance the investment that produces growth. The key insight is that saving has to rise more than investment in order to allow also for the accumulation of precautionary assets. As a consequence, entrepreneurs generate a net saving increase that sustains persistent net capital outflows. Plausibly calibrated simulations produce sizeable quantitative effects. I then show that the introduction of state contingent claims reduces capital out flows, speeds up growth and leads to substantial welfare gains.
Keywords: capital flows, growth, entrepreneurship, idiosyncratic risk, heterogeneity, financial underdevelopment, saving
JEL Classification: C6, E2, F4, O1
Suggested Citation: Suggested Citation