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UBC Theses and Dissertations

The role of capital flows and savings in the growth process Verdier, Geneviève

Abstract

The goal of this dissertation is to address the following questions: Why do growing economies borrow? Are the neoclassical forces that drive accumulation the main impulse behind long-term cross-country movements in capital? What class of models best describes observed capital flows? A standard view of capital flows is that they are driven by scarcity, and act as a substitute to domestic savings. Countries borrow to accumulate capital, and by using international capital markets, can increase investment with no cost in current consumption: foreign financing replaces domestic savings. An alternative view is that factors other than the domestic scarcity of capital may drive inflows from abroad. For example, in the presence of collateral constraints, countries that are willing to cut current consumption to accumulate domestic capital may be rewarded by additional inflows, i.e. capital inflows may complement domestic savings. In the first essay, I examine whether the qualitative implications of a simple neoclassical model with collateral constraints fit the long-term movements in external debt. The most surprising prediction of this class of models is that, contrary to a pure neoclassical model, domestic savings should act as a complement rather than a substitute to capital inflows. Nevertheless, this class of models still predicts that, ceteris paribus, capital should flow to the countries where it is most scarce. Using data on debt between 1970 and 1997 for high-income as well as middle-income developing economies, I find evidence that supports the prediction that domestic savings play a complementary role. These result suggest that policies that affect national savings may potentially be important for capital accumulation and growth, even in open economies. The second essay of the thesis evaluates the quantitative performance of this class of models, by focusing on the model developed by Barro, Mankiw and Sala-i-Martin [1995]. Specifically, I ask what factor shares are implied by the cross-country variations in debt accumulation examined in the first essay. The model, which features decreasing returns and a complementary role for savings, is solved and simulated using non-linear techniques. Factor shares are then estimated using a method of indirect inference by comparing simulated and actual debt data. The model implies fairly high, though not implausible, shares of composite capital, without completely matching the effect of the savings rate. It does however, consistently predict unrealistically high debt-to-GDP ratios. In the third essay, I consider and evaluate an alternative model of debt. A neoclassical model with capital adjustment costs and a debt-elastic interest rate is examined to determine whether an alternative model, more standard in the literature, can match the observed convergence equation on debt. I find that although qualitatively the model allows for the possibility that capital inflows can be both complements and substitutes to domestic savings, quantitatively, the model is odds with the data. These results suggest that two mechanisms — decreasing returns and the complementarity between domestic savings and foreign financing — are quantitatively important. They cannot however, fully account for the observed variations in debt and income. Modeling the dynamics of the debt-to-output ratio is a promising avenue for future research.

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