Commentary: Patterns of International Capital Flows and Their Implications for Economic Development

In their wide-ranging paper, Prasad, Rajan, and Subramanian (PRS) update and explore a new dimension of the well-established, though seemingly perverse, Lucas puzzle—that capital tends to flow from poor to rich countries. Building on the recent finding by Gourinchas and Jeanne (2006) that capital flows to nonindustrial countries have been relatively concentrated among the slow, not the rapid growers, PRS document that current account balances for these countries are also positively correlated with long-run growth. Thus, countries that grew more quickly have been less reliant on foreign finance. In contrast, they find the opposite (but expected) negative correlation for industrial countries. After presenting a variety of relevant empirical relationships, the authors consider possible explanations for this new “stylized fact.” Their preferred hypotheses focus on the role of underdeveloped domestic financial markets that limit countries’ ability to absorb foreign capital and on countries’ desire to avoid capital inflows that would cause overvaluation. They also discuss a variety of possible implications, including for interpreting recent global imbalances and informing policy toward capital account openness.