Gross Capital Flows and the Returns to Capital

This paper builds a two region world economy in which domestic and foreign capital are complements to each other. This framework provides a simple and rich framework to study the taxonomy of international capital ‡ows and their macroeconomic implications. We show in particular that the equilibrium of the global capital market can be such that countries import and export capital at the same time. In this case, we derive three properties. First there can be multiple equilibria in the size and the direction of capital ‡ows, thereby providing some theoretical underpinnings to episodes of capital ‡ow reversals. Second when the equilibrium is unique, countries with larger capital markets are more likely every thing else equal to be net capital importers. Finally countries with more e¢ cient …nancial markets are shown to run a net positive return on external assets compared to external liabilities.