Barriers on Capital Flows and Growth

The lower barrier on capital mobility has stimulated capital flows across countries. Whether capital flows would promote economic growth is still not clear. This paper argues that whether the capital flow would promote growth depends crucially on three factors, the preferences of depositors, the relative technology level of domestic and foreign countries and the barrier of capital mobility in the foreign country. By extending the model of Chang (2005) and allowing for capital inflow and outflow, I find several interesting results. First, without capital flows, patient depositors would increase the loans available to the entrepreneurs, and promote economic growth. Second, with capital flows, whether the outflow capital would flow back to the economy would depend on the relative technology levels of two countries and the barrier of capital flows in the foreign country. If the technology of accumulating capital is higher in the foreign country, which does not have restrictions on capital flows, then the capital outflow caused by factory relocation may promote growth, because the capital accumulated in the foreign country may flow back and promote domestic economic growth. If the country which domestic capital has flowed to has high barrier on capital mobility, then it is more likely that capital outflow to that country has no contribution to domestic economic growth, and may also damage domestic growth.