Financial Integration, Entrepreneurial Risk and Global Dynamics

How does nancial integration impact capital accumulation, current-account dynamics, and cross-country inequality? This paper investigates this question within a two-country, generalequilibrium, incomplete-markets model that focuses on the importance of idiosyncratic entrepreneurial risk a risk that introduces, not only a precautionary motive for saving, but also a wedge between the interest rate and the marginal product of capital. Our contribution is then to show that this friction provides a simple explanation for the emergence of global imbalances, a simple resolution to the empirical puzzle that capital often fails to ow from the rich or slowgrowing countries to the poor or fast-growing ones, and a distinct set of policy lessons regarding the intertemporal costs and bene ts of capital-account liberalization. JEL codes: E13, F15, F41.