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Wealth composition, capital flows, and the international financial system




Baqais, Uthman Mohammed S., author
Vasudevan, Ramaa, advisor
Bernasek, Alexandra, committee member
Braunstein, Elissa, committee member
Koontz, Stephen, committee member

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International capital flows play a critical role in the development process. On the one hand, a stable stream of capital flows could augment the capital stock accumulation of a country and, hence, spur economic growth. On the other, volatile capital flows increase the risks that could induce financial and economic crises. Moreover, contrary to the efficient allocation implied by the neoclassical growth theory, Lucas (1990) poses the paradox of "Why Doesn't Capital Flow from Rich to Poor Countries?". Recent studies also demonstrate an even stronger phenomenon known as the allocation puzzle or upstream capital flows. That is, fast-growing emerging markets have associated with net capital outflows on average (e.g., Gourinchas and Jeanne 2013). While previous studies provide explanations about cross-country differences in human capital (Lucas 1990), institutional quality (Alfaro et al. 2008), I argue that the capital flows are also explained by differences in natural resources in the current era of financial globalization. In general, I demonstrate the role of initial wealth compositions. In this dissertation, I define capital stock more broadly than the standard neoclassical growth model in terms of wealth accumulation, comprising physical capital, human capital, natural capital, net foreign assets, social capital, and domestic financial capital (as in Gylfason 2004). By exploiting a recent database on wealth accounting by the World Bank, I find that the wealth composition matters in explaining capital flows across 108 countries over 1995-2015. More importantly, results of Chapter 1 suggest that initial abundance measures of subsoil natural resources and net foreign asset positions explain much of the subsequent annualized average net capital inflows. An alternative measure of net capital inflows also suggests a stabilizing role of the valuation effects in the international financial system. In sum, measures of wealth abundance and net capital inflows should be considered carefully in studying the patterns of international capital flows. Results from the typical measure suggest that capital mobility allows subsoil resource-rich countries to invest their resource rents abroad, so they could better smooth the use of resource windfalls. Therefore, the inclusion of natural capital emphasizes the role of economic management in whether to channel rents toward productive investment and human capital to industrialize the economy, or to accumulate foreign assets for exchange rates managements and for precautionary motives due to volatile international commodity prices. It should be noted that there is no evidence on the neoclassical allocative efficiency— the relationship between economic growth rates and net capital inflows. Due to the insignificant finding of the allocative efficiency, Chapters 2 and 3 extend and modify the first chapter's conceptual framework. Chapter 2 investigates not only international capital flows but also some explanations for the persistent global imbalances. Using a unified sustainable growth framework with a broad definition of total wealth, I demonstrate that there could be specific spillover effects (or specific complementarities) rather than an overall complementarity effect, which is simply proxied by real per capita growth rates. For instance, the interaction between human capital and physical capital generates a positive spillover effect, as explained by Lucas (1990). Thus, the departure from the focus on the overall complementarity to specific complementarities and tradeoffs in capital stocks provides us with a way of testing for 13 hypotheses, motivated by the broad literature of international finance and sustainable development. Some of these are about a human capital externality, the global saving glut argument, and negative spillover effects from natural capital on institutions and financial development. I also test for Blecker's (2005) argument on comparative advantage in selling financial assets and find supporting evidence. The implication of such findings implies that the current account (CA) deficit countries with highly developed financial systems have benefited from the current international monetary and financial system (IMFS) through the role of valuation effects. On the other hand, financial liberalization allows subsoil-rich economies to smooth the use of windfalls through foreign reserves accumulation. Other developing countries with CA surpluses due to excess savings, rather than low imports, reflect the flaws in the current IMFS. Chapter 3 is motivated by utilizing theoretical insights from overlapping generations (OLG) models with non-Ricardian equivalence, rather than the assumption of the infinitely lived agent as in previous chapters. I, therefore, examine not only net total capital inflows but also consider the distinction of private and official flows. In addition to the heterogeneities in economies' wealth compositions, I investigate the role of demographic structures by highlighting the aging population phenomenon. In other words, while using the unified sustainable growth framework with a broad definition of wealth, I distinguish between private and official capital flows, and between the relative ratios of young and old groups to the working-age population. All these factors relate to capital flow movements through their effects on saving-investment decisions. Overall findings support the adoption of OLG with non-Ricardian equivalence models in analyzing aggregated and disaggregated capital flows. Also, the inclusion of demographic factors seems to correct for the omitted variable bias. Moreover, cross-country differences in initial wealth compositions are of great importance for different types of disaggregated capital flows, and so policy implications differ accordingly.


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financial globalization
international financial system
sustainable development
global imbalances
capital flows
open economy growth


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