The Determinants Of Two-way International Capital Flows

According to the Neo-classical theory, capital should flow to capital-scarceddeveloping countries due to their relatively higher rate of return than those developedcountries, however in real world the capital is actually flowing to capital-abundantdeveloped countries. In addition, there exists the so called "two-way internationalcapital flow" paradox, i.e. many developing countries are both net importers of foreigndirect investment (FDI) and the net exporters of financial capital, while many developedcountries do the reverse.This paper proposes a general equilibrium model which illustrates that the bypassof the low technology, poor property right protection, and inefficient financial systemfor developing countries may be the main reason for two-way capital flow. Fordeveloping countries, with the improvement of technology, property right protection,financial system efficiency, market transparency and corporate governance, they willattract more capital inflow.In this paper, we also analyze the effects of financial globalization on differentcountries. While financial globalization always improves the welfare of a developedcountry, its effect is ambiguous for a developing country. However, as the enhancementof property right protection or market transparency for the developing countries, thosecountries are more likely to be benefited from the financial globalization.For those implications derived by the general equilibrium model, we conductedempirical study with the global sample. The empirical results demonstrate that thetwo-way international capital flow indeed can be robustly interpreted by the threefactors proposed by the model. Specifically, property right protection and financialdevelopment play significant roles for the direct investment flow, while technology,property right protection and financial development all have noteworthy impacts onfinancial capital flow.Finally, we analyze the capital control in China, a very concerned phenomenon,and show that capital controls have both apparent restrictions on capital inflow andoutflow, however for the net capital flow, the impacts are insignificant. Specifically,China's capital controls on inflow, long-term capital and direct investment have moresignificant effects than those on outflow, short-term capital and financial capital respectively. In addition, for China's capital flow, the impact is larger for looseningcapital controls than strengthening them.Our study offers significant implications for understanding of the two-wayinternational capital flow and "Lucas Paradox", and provides useful guidance forliberalizing China's capital account.