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Does foreign capital go where the returns are? Financial integration and capital allocation efficiency 1
Author(s) -
Mann Katja
Publication year - 2021
Publication title -
international journal of finance and economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.505
H-Index - 39
eISSN - 1099-1158
pISSN - 1076-9307
DOI - 10.1002/ijfe.1998
Subject(s) - economics , investment (military) , capital (architecture) , monetary economics , financial capital , consumption (sociology) , financial integration , capital allocation line , physical capital , capital deepening , capital formation , macroeconomics , financial market , finance , microeconomics , human capital , market economy , profit (economics) , social science , archaeology , sociology , politics , political science , law , history
This paper asks whether financial integration leads to a more efficient allocation of capital within economies. I build a model of a small economy with an investment and a consumption goods sector. Financial frictions impede capital from allocating optimally between the two sectors. Capital account opening has positive allocation effects if the economy is financially less developed than the rest of the world, but negative effects otherwise. I test the model predictions on a sample of 113 countries, using the relative price of consumption and investment goods as a measure of allocation efficiency. I find that international capital flows indeed have adverse effects in highly developed countries, whereas there is less evidence of positive effects in low‐development countries. Overall, financial integration leads to more similar capital allocations across countries.