Patterns of International Capital Flows and Their Implications for Economic Development

Economic theory posits that capital should, on net, flow from richer to poorer countries. Specifically, in the benchmark neoclassical model, capital should flow from countries that have relatively high capital-to-labor ratios to countries that have relatively low ratios. In an influential paper, Lucas (1990) notes that flows of capital from the north to the south are nowhere near the levels predicted by theory. Financial globalization has taken off in the decade and a half since Lucas wrote his paper, with a substantial increase in cross-border capital flows. Nonindustrial countries, especially the group of emerging market economies, have become much more integrated into international financial markets. What has become of the empirical paradox that Lucas identified? Has increasing financial integration resolved it?