Global Imbalances or why are the Poor Financing the Rich?

Summary Traditional economic models predict that capital should flow from capital-rich to capital-poor economies. In recent years, capital has been flowing in the opposite direction, although foreign direct investment flows do behave more in line with theory. Do these perverse patterns of flows dampen growth in non-industrial countries by depriving them of financing for investment? On the contrary, the evidence suggests non-industrial countries that have relied more on foreign finance have not grown faster in the long run. At the same time, growth and the extent of foreign financing are positively correlated in industrial countries. I argue that the reason for this difference may lie in the limited ability of non-industrial countries to absorb foreign capital. This paper draws heavily from work with Eswar Prasad and Arvind Subramanian, who should share the credit for the contents. I alone am responsible for remaining errors.