The movement of capital from the emerging markets to the United States: An analytical view

Abstract

The world has indeed become smaller in the terms of finance. Today, the investors are able to invest in other economies (due to open economies and liberalized policies) to receive a “Risk adjusted return” for their investment. The financial crisis of 2008 (and of before), have taught a lesson to the investors across the globe to look for safe and liquid assets. This has not only resulted in an increased capital flow in the global arena but also presented an intellectually stimulating scenario to the world. We characterize the patterns of capital flows between rich and poor countries. Neoclassical economic models predict that capital should flow from capital-rich to capital-poor economies. However, Robert Lucas in 1990s wrote a Research paper on the inverse capital flow stating that capital flows from poor to rich countries. We find that, in recent years, capital has been flowing in the opposite direction, although foreign direct investment flows do behave more in line with theory. My objective in this paper is to find out the reason (by an analytical approach) behind the Paradox.