Financial Integration, Capital Mobility, and Income Convergence
70 Pages Posted: 9 Feb 2009
Date Written: September 1, 2008
Recent studies have found that capital moves "uphill" from poor to rich countries, and, when it does flow into poor economies, it brings little or no growth dividend. This stylization is emerging as a new orthodoxy, with predictive and normative implications. In this paper, we report that Europe provides a counterexample that supports a more conventional textbook perspective. As financial integration in Europe has increased, capital has traveled "downhill" with gathering strength from rich to poor countries. Moreover, these inflows have been associated with significant acceleration of income convergence. Although sympathetic to a view that growth dynamics may vary across countries and regions for deep historical and geographical reasons, we do search for an overarching explanation. We find that countries above certain thresholds in institutional quality and in financial integration itself tend to experience stronger downhill capital flows; thresholds have a less clear impact on income convergence. Europe, however, remains different even when allowing for thresholds. Europe's recent experience bears closer correspondence with intranational flows within the United States. That leads to two possibilities. First, more akin to an intranational setting, the European experience may have limited relevance for regions where borders still represent significant barriers. However, the threshold effects of financial integration point to a second, more intriguing possibility: the downhill flow of capital observed in a highly integrated Europe may well be the leading edge, the bellwether. With the increased diversification associated with integration, countries' incentives to self-insure - through high savings rates and postponed consumption - may become less compelling.
Keywords: Current account deficits, capital flows, capital mobility, financial integration, growth, convergence
JEL Classification: F43, F21, F36
Suggested Citation: Suggested Citation