Why does capital flow from poor to rich countries?

This was the question posed by Prof Robert Lucas decades ago.

Daniel Gros says we need to reframe the question:

Why does capital flow from poor to rich countries? This column argues that the direction of capital flows makes economic sense given savings behaviour. But the real puzzle is why savings rates are high in poor countries and low in rich ones.

The real puzzle is thus not where the investment goes, but the savings rates which are much higher in emerging economies, allowing them to finance their own development out of their own resources.

When Lucas wrote his seminal paper in 1990 the investment rate in emerging economies was much lower than today and they were running consistent current-account deficits – i.e. their investment rates exceeded their savings rates.

At the time puzzle was why there was not more investment in the capital-poor countries. Today the investment rate is more than 10 percentage points of GDP higher in emerging economies than in advanced economies. If their savings rate had remained unchanged emerging countries would be running very large current-account deficits and would thus be importing a lot of capital. However, their savings rates have increased even more than their investment rates and the real puzzle has become: “Why do poor countries save so much?”

 Some research shows that they save as there are no adequate social security systems, lack of financial products and so on…

2 Responses to “Why does capital flow from poor to rich countries?”

  1. Loknath Rao Says:

    I think some economist now needs to really introspect why emerging economies are more expensive than developed economies when it comes to almost about everything. We need to compare apple to apple. So question arises why an apartment in south Mumbai is more expensive than an apartment in Manhattan ?.

    As a layman who has not studied economics, I have a laymans answer. Globalization and liberalization for emerging economies meant the big foreign corporations who want to get richer quick spend in Rupees but expect revenues in dollars. Take Pizza hut as an example. Everything they use is 100% local. incl. the labor but the price of medium veggie pizza is SAME as in United States, converting dollars to rupees directly.

    Same is true of All foreign Automakers, branded garments. A Levis 501 retails for 75 to 100 dollars in US and 3000 to 4000 Rupees in India. It is 100% made in India. I can cite 500 basic products that are cheaper in wal mart vis a vis the local Kirana shop.

  2. For the first time, the combined GDP of poor nations is greater than the rich ones | pundit from another planet Says:

    […] Why does capital flow from poor to rich countries? (mostlyeconomics.wordpress.com) […]

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