Does Competition for Capital Discipline Governments

Many political economists believe that competition among countries—or regions within them—to attract mobile capital disciplines their governments, motivating them to invest more in infrastructure, reduce waste and corruption, and spend less on non-productive public goods. The result should be convergence on business-friendly policies and clean government. The notion that mobile capital disciplines governments is central to debates on both political decentralization and globalization. We argue that it requires an assumption—countries or regions start out identical—that is unrealistic. If units are sufficiently heterogeneous (in natural resources, geographical location, inherited human capital or infrastructure), we show that capital mobility often weakens discipline on the poorly-endowed units and increases policy divergence. While better-endowed units do invest more in infrastructure—and are rewarded by capital inflows—poorly endowed units may actually be less businessfriendly or more corrupt than under capital immobility. This may help explain disappointing results of liberalizing capital flows within the Russian federation and sub-Saharan Africa.