DP6561 Capital Flows to Developing Countries: The Allocation Puzzle

Author(s): Pierre-Olivier Gourinchas , Olivier Jeanne

Publication Date: November 2007

Keyword(s): capital flows , Lucas puzzle

JEL(s): F21 , F36 , F43

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP6561.asp.asp

According to the consensus view in growth and development economics, cross country differences in per-capita income largely reflect differences in countries' total factor productivity. We argue that this view has powerful implications for patterns of capital flows: everything else equal, countries with faster productivity growth should invest more, and attract more foreign capital. We then show that the pattern of net capital flows across developing countries is not consistent with this prediction. If anything, capital seems to flow more to countries that invest and grow less. We argue that this result - which we call the allocation puzzle - constitutes an important challenge for economic research, and discuss some possible research avenues to solve the puzzle.