Capital Flows, and Global Imbalances. Volosovych. Hiro Ito Portland State University IEFS Session, ASSA 2012 January 7, 2012

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1 Comments on Sovereigns, Upstream Capital Flows, and Global Imbalances by L. Alfaro, S. Kalemli-Ozcan Ozcan, and V. Volosovych Hiro Ito Portland State University IEFS Session, ASSA 2012 January 7, 2012

2 I really like this paper because It is interesting and deals with a timely issue It helps untangle the Lucas Paradox It is easy to read The conclusions are quite clear despite an extensive number of regression exercises

3 The Paper Concludes: The Lucas Paradox seems to reflect the characteristics of aggregate capital flows, but once capital flows are disaggregated, d it does not necessarily exist i.e., corr(k-inflow, y) > 0 is found for: equity (i.e., FDI and portfolio) flows private debt flows Consistent with the neoclassical theory corr(k-inflow, y) < 0 is found for: sovereign debt flows aid The global imbalances are a phenomenon that reflects sovereign-to-sovereign i borrowing and lending

4 The paper s conclusions are nice and clear, and easy to swallow, but I would like to raise several issues Issue #1-1: The link b/w capital flows and economic growth can be bidirectional theoretically ti (econ growth K-flows) A poor country should have its marginal product of capital (r) higher than the world interest rate (r w ) while its growth rate is higher than the world growth rate. Hence, in a financially open world, capital should flow to high-growth h economies (K-flows econ growth) Poor countries with domestic distortions and financial Poor countries with domestic distortions and financial constraint may grow faster if foreign finance can help domestic capital formation, thus leading to faster economic growth. Prasad, Rajan, and Subramanian (2007) tested this causality

5 The paper s conclusions are clear and easy to swallow, but I would like to raise two issues Issue #1-2: The link b/w capital flows and economic growth can be bidirectional empirically The cross-sectional sectional analysis only shows correlation, not causality, though the authors focus on the causality from economic growth to (different types of) K-inflows There is no control for the direction of causality Maybe panel data analysis is needed?

6 Issue #2: Why corr(public debt, y) > 0 and corr(equity, y) < 0? The reader cannot help wondering why developing countries have corr(debt, y) > 0 and corr(equity, y) < 0 Possibility #1: Financial constraint and lack of financial openness Gov t authorities may function as an agent for the private sector that faces financial constraint and/or outward capital controls and help it diversify risk Financial constraint fewer investment opportunities in domestic market Outward K-control Gov t authorities make investment instead of private citizens

7 Issue #2: Why corr(debt, y) > 0 and corr(equity, y) < 0? If that prediction is right, the following must be true: Corr(equity, ppg-res) < 0 if financially underdeveloped, Corr(equity, ppg-res) > 0 if financially i developed, d and/or Corr(equity, ppg-res) < 0 if financially closed, Corr(equity, ppg-res) > 0 if financially i open 1 1 MAR MAR equity flows and PPG.5 Correlation b/w e SWZ KGZ GHA. FJI TUN IRN JAM PAN LBN ARM MWI GTMCRI LTU BGR PAK VEN IDN PHL VNM KNA KEN EGYMUS BGD PNG RUS ZMB MDA LVẠ MNG LKA URY ARG TUR THA PRY NPL ECU PER CHN IND TZANGA KAZ SLV JOR GUY ZWE UKR GEO ROM COL BOL BRA BWAMEX MKD CHL HND UGA MYS ZAF equity flows and PPG.5 Correlation b/w e SYC DJI TGO SWZ KGZ ZAR. TUN FJI BIH BLR GHA WSM TCD HTI LBR IRN CPV ERI GIN JAM LBN PAN MWI LCA GMB PAK ALB ARM CRI GTM SDN BGR LTU COM VNMKNA PHL CMR VCT BEN VEN IDN MDV BTN BFA NER ETH EGY BGD GAB KEN MUS GNB COG YEM LSO PNG RUS KHM VUT LAO MRT AZE MDA RWA LVA GRD TUR DOM TONTHA SYR MLI LKA ARG MYS MNG ZMB CHN BDIND NPL SEN DMA ECU PRY PER ZWE KAZ JOR URY TZA NGA CAF GUY SLV ZAF TJK BLZ BRA COL MDG TKM UKR ROM GEO MOZ NIC AGO UZB SLE MEX BOL BWA MKD. SLB CHL HND DZA UGA Measure of Financial Development 1st prin. comp. of PCGDP, SMKC, SMTV Measure of Financial Openness 2 3 Chinn-Ito index

8 Issue #2: Why corr(debt, y) > 0 and corr(equity, y) < 0? Possibility #2: Jeanne (2011) argues: US government debt has given a low (and in fact negative) return to the countries that accumulated the most reserves Maybe countries are accepting low or negative return as insurance premium for financial crisis? In any case, the big issue is not about whether correcting domestic distortions or global interventions are appropriate (p.30) The paper will become more interesting to dig further on this issue

9 Issue #3: Is the private sector really consistent with the Solow framework? In order for the Solow model to hold, smooth and functioning financial intermediation is necessary to convert S into I But domestic financial markets of developing countries are full of distortions Allen et al. (2008) banks and markets have played a limited role in providing funds for corporate sectors and supporting economic growth in India and China Ratios of ownership by family/individuals id l (Allen et al., 2008) Chinese firms: 21% Indian firms: 78% Medium (Large)-size firms in other EMGs: 51% (30%) Countries are market-oriented externally, but far from market mechanism domestically? Need more reconciliation

10 Issue #4: The neoclassical model focuses on the relationship b/w the rate of return and capital flows, but Economic growth may not be a good proxy for the rate of return Henry (2007): Identical two countries, A and B, both initially at the steady state Only A increases its saving rate it invests more it ll reach a higher level of per capita capital and income lower marginal product of capital = lower rate of return return to the same steady state economic growth as B

11 In any case, it is a very interesting paper The authors add important and interesting issues to the current debate on the global l imbalances We should all read the paper

12 THANK YOU!!