Does Foreign Capital Go Where the Returns Are? Financial Integration and Capital Allocation Efficiency

Katja Mann*

*Corresponding author af dette arbejde

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This paper asks whether financial integration leads to a more efficient allocation of capital within economies. I build a model of a small economy with an investment and a consumption goods sector. Financial frictions impede capital from allocating optimally between the two sectors. Capital account opening has positive allocation effects if the economy is financially less developed than the rest of the world, but negative effects otherwise. I test the model predictions on a sample of 113 countries, using the relative price of consumption and investment goods as a measure of allocation efficiency. I find that international capital flows indeed have adverse effects in highly developed countries, whereas there is less evidence of positive effects in low-development countries. Overall, financial integration leads to more similar capital allocations across countries.
TidsskriftInternational Journal of Finance and Economics
Udgave nummer3
Sider (fra-til)3945-3971
Antal sider27
StatusUdgivet - jul. 2021

Bibliografisk note

Published online: 12. August 2020


  • Capital allocation
  • Financial development
  • Financial integration
  • International investment
  • Relative prices