Barriers to Global Capital Allocation
71 Pages Posted: 13 Jan 2021 Last revised: 13 Jan 2022
There are 3 versions of this paper
Barriers to Global Capital Allocation
Barriers to Global Capital Allocation
Barriers to Global Capital Allocation
Date Written: December 21, 2020
Abstract
Observed patterns of international investment are difficult to reconcile with frictionless capital markets. In this paper, we provide a quantitative theory of international capital allocation: a multi-country dynamic general equilibrium model with rationally-inattentive investors, where cross-border investment is subject to both information and policy frictions. These frictions result in a persistent misallocation of capital across countries. We estimate model parameters using nationality-based, bilateral investment data, and measures of geographic, linguistic and cultural distance, which capture information frictions. Our unified theoretical-empirical framework can account for several stylized facts: the gravity structure of investment flows, home bias, persistent global imbalances and capital return differentials across countries, as well as the paucity of net flows from developed to emerging economies. Finally, we perform counterfactual exercises: we find that information and policy barriers to international investment greatly amplify the capital gap between rich and poor countries, and result in a large reduction in world output.
Keywords: Capital Flows, Foreign Investment, Culture, Institutions, Geography, Gravity, Interna- tional Macroeconomics, International Finance, Open Economy
JEL Classification: E22, E44, F2, F3, F4, G15, O4
Suggested Citation: Suggested Citation