Why Doesn't Capital Flow from Rich to Poor Countries? ⑧ Robert E. Lucas, Jr. The American Economic Review,vol.80,no.2, Papers and Proceedings of the Hundred and Second Annual Meeting of the American Economic Association. (May, 1990), pp. 92-96 Stable URL http: //links. istor.org/sici ? sici=0002-8282%28199005%2980%3a23C92%3AWDCFFR%3E2.0.C0%3B2-J The American Economic Review is currently published by American Economic Association. Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://ww.jstor. org/abou/terms. html. istor's terms and conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://www.jstor. org/journals/aea. html. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. JSTOR is an independent not-for-profit organization dedicated to creating and preserving a digital archive of scholarly journals. For more information regarding JSTOR, please contact support@jstor.org. http://www.jstor.org/ Mon Sep1800:29:262006
Why Doesn' t Capital Flow from Rich to Poor Countries? By ROBERT E. LUCAS, JR The egalitarian predictions of the simplest capital per worker, and thus neoclassical models of trade and growth are well known and easy to explain, as they (2) =BA1y(B-D∥ follow from entirely standard assumptions on technology alone. Consider two countries in terms of production per worker. Let B producing the same good with the on- 0.4 (an average of U.s. and Indian capital stant returns to scale production function, shares), again for both countries. Then the relating output to homogeneous capital and formula(2)implies that the marginal prod- yorker dif- uct of capital in India m fers between these two countries, it must be =58 times the marginal product of capital because they have different levels of capital in the United States I ha ruled If this model were anywhere close to being out! Then the Law of Diminishing Returns accurate, and if world capital markets were implies that the marginal product of capital anywhere close to being free and complete, it is higher in the less productive (i.e, in the is clear that, in the face of return differen- poorer) economy. If so, then if trade in tials of this magnitude, investment goods capital good is free and competitive, new would flow rapidly from the United States investment will occur only in the and other wealthy countries to India and economy, and this will continue to other poor countries. Indeed, one would ex- I capital-labor ratios, and hence ivestment to occur in the wealthy and capital returns, are equalized countries in the face of return differentials of We do, of course, see some investment by this magnitude. I worked out the arithmetic wealthy countries in poorer ones, but an for this example to make it clear that there example with some rough numbers will help nothing at all delicate about this standard we observe ar just how far the capital flows neoclassical prediction on capital flows.The by the theory I have just sketched. Accord- tions that give rise to this example must be ing to Robert Summers and Alan Heston drastically wrong, but exactly what is wrong (1988, Table 3, pp. 18-21), production per with them, and what assumptions should person in the United States is about fifteen replace them? This is a central question for times what it is in India. Suppose produc- economic development. I consider four tion in both these countries obeys a Cobb- didate answers to this question Douglas-type constant returns technology with a common intercept (1) The sample calculation in my introduction treats effective labor input per person as where y is income per worker and x qual in the countries being compared, ig- capital per worker. Then the marginal prod- noring differences in labor quality or human uct of capital is r=ABx8-, in terms capital per worker. The best attempt to cor rect measured labor inputs for differences in human capital is Anne Krueger's study (1968). Her estimates are based on data from the 1950s, but the percentage income differ- and for entials between very rich and very poor research support countries have not changed all that much in
VOL. 80 NO. 2 THE"NEW" GROWTH THEORY the last 25 years and, in any case, a rough economic motive for capital to flow, there estimate is better than none at all. Her would be no motive for labor flows either method is to combine information on each Yet we see immigration at maximal allow country's mix of workers by level of educa- able rates and beyond from poor countries tion, age and sector with U. S. estimates of to wealthy ones. We do not want to resolve the way these factors affect worker produc- the puzzle of capital flows with a theory that tivity, as measured by relative earnings predicts, contrary to the evidence provided Krueger's main results are given in her by millions of Mexicans, that Mexican work Table Il(p. 653), that gives estimates of the ers can earn equal wages in the United States per capita income that each of the 28 coun- and in Mexico tries examined could attain, expressed as a fraction of U.S. income, if each country had Il. External Benefits of Human Capital the same physical capital per worker endow ment as did the United States. The estimates Obviously, we could resolve the puzzle of ange from around 38(India, Indonesia, the ina uac ows at any Ghana) to unity(Canada) and 84 (Israel). by assuming that marginal products of capi These numbers have the dimension of the tal are equalized, and using equation(2)and relative human capital stocks raised to the the estimated income differential to estimate ower of labor's share, so taking the latter at the relative levels of the intercept parameter 6(as I did in my introductory example), the A (often called the level of technology) in the two countries being compared. This is ments ranged from about. 2 to unity. That is, almost what I will do in this secto ach american or Canadian worker was esti- will do so in a way that has more content, by mated to be the productive equivalent of assuming that an economy's technology level about five Indians or Ghanians (Compensa- is just the average level of its workers'hu ion per employed civilian in the United man capital raised to a power. That is, I States in 1987 was about $24,000, so this assume(as in my 1988 paper), that the pro- estimate implies that a typical worker from duction function takes the form ndia or Ghana could earn about $4800 in the United States.) Krueger's estimated human capital diffe (3) tials, reinterpret y in equations (1)aden. where y is income per effective worker, x is capital per effective worker, and h is human s income per effective worker. Then the capital per worker. I interpret the term hYas ratio of y in the United States to y in India an external effect gust as in Paul romer, becomes 3 rather than 15, and the predicted 1986). It multiplies the productivity of rate of return ratio becomes(3)5=5 rather worker at any skill level h, exactly as does than 58. This is a substantial revision, but the intercept A in (3 even so, it leaves the original paradox very The marginal productivity of capital for much alive: a factor of 5 difference in rates mula implied by ( 3)is of return is still large enough to lead one to xpect capital flows much larger than any- (4) r=BA/y(8-1/hv/8 thing we observe If it had turned out that replacing labor I propose to estimate the parameter y using with effective labor had entirely eliminated Edward Denisons(1962)comparison of U. s stimated differences in the marginal prod- productivity in 1909 and 1958, and then to uct of capital, this would have answered the apply this estimate to (4) using Krueger's question with which I began this paper, but cross-country estimates of relative human only by replacing it with an even harder capital stocks in 1959 to obtain question. Under constant returns, equal cap diction on relative rates of return on capital i returns implies equa al wage rates for The estimation of y is as reported in my equally skilled labor, so that if there were no earlier paper(1988, p. 23). Using Denison,s
AEA PAPERS AND PROCEEDINGS AY990 estimates for the 1909-59 period. in the tion and the preceding one United States, output power man-hour grew correcting for human capita 如m tials re- about one percentage point faster than capi duces the predicted return tal per man-hour. Denison estimates a very rich and very poor countries from about growth rate of h, attributed entirely to 58 at least to about 5, and possibly, if knowl- growth in schooling, of 009. With the tech- edge spillovers are local enough, to unity nology(3), this implies that(1-B+y)time he growth rate. 009 of human capital equals Ill. Capital Market Imperfections 01. With a capital's share B= 25, these numbers imply y=36. That is to say, a 10 I have been discussing capital flows in percent increase in the average quality of static terms, taking it for granted that dif- those with whom I work increases my pro- ferences in marginal products of capital at a based on the assumption that the total stock through time. In the one -good context I am of human capital grows at the same rate using, such flows are simply borrowing con- 009, as that part of the stock that is accumu- tracts: the poor country acquires capital from lated through formal schooling. I do not the rich now, in return for promised good have any idea how accurate an assumption flows in the opposite direction later on this is Suppose countries A and B are engaged Now taking the Krueger estimate that five in such a transaction, and that the capital Indians equals one American, the predicted stocks in the two countries are growing on rate of return ratio between India and the paths that will eventually converge to a com- United States becomes(3).5-=1.04. That mon value. If we look at goods flows through is, taking the external effects of human capi time between these two countries, we al into account in the way I have done phase in which goods fow from advanced A entirely eliminates the predicted return dif- to backward B, followed by a phase(which ferential. Notice that this result is in no way lasts forever)in which goods flow from B to built into my estimation procedure. The value A in the form of interest payments or repa of y estimated from the 1909-58 U.S. com- triated profits. This sort of pattern was im- parison exactly eliminates the return differ- plicit in my statement of the capital fiow ential in a 1959 India-US comparison problem. For such a pattern to be a competi- One might accept this calculation as a tive equilibrium, it is evident that there must resolution of the question I posed in my be an effective mechanism for enforcing in- title. This was the argument in my earlier ternational borrowing agreements. Other paper, based on U.S. data only, and I am wise, country B will gain by terminating its surprised how well it works in a cross-coun- relationship with A at the point where the try comparison. But it portant epayment p blesome I think, to note that the cross-coun- this, country A will never lend in the first comparison is based on the assumption place. A capital market imperfection of this that the external benefits of a countrys stock type is often summarized by the term" polit of human capital accrue entirely to produc- ical risk ers within that country. Knowledge spillovers A serious difficulty with political risk as across national boundaries are assumed to an explanation for the inadequacy of capital be zero. Ordinary experience suggests that flows lies in the novelty of the current politi while some of the external benefits of in- cal arrangements between rich and poor na creases in individual knowledge are local, tions. Until around 1945, much of the Third confined to single cities or even small neigh- World was subject to European-imposed le- orhoods of cities, others are worldwide in gal and economic arrangements, and had scope. But, without some real evidence on been so for decades or even centuries. A the scope of these external effects, I do not European lending to a borrower in India or see how to advance this quantitative discus- the Dutch East Indies could expect his con- sion any further. The argument of this sec- tract to be enforced with exactly the same
VOL. 80 NO THE"NEW GROWTH THEORY effectiveness and by exactly the same means With the Cobb-Douglas technology as- as a contract with a domestic borrower. Even sumed in my earlier examples, the formula if political risk has been a force limiting (6)implies that r=B2x -l=Bf(x). with a capital flows since 1945, why were not ratios B value of. 4, then, the return on capital in of capital to effective labor equalized by the colony should be about 2.5 times the capital flows in the two centuries before European return. These are quantitativel interesting rents. The possibility that such I do not know the answer to this question rents were important is, I think, reinforced but, in seeking one, I see no reason to as- by many of the institutional features of the sume that the role of the colonial powers colonial era: the carving up of the Third was simply to enforce a laissez-faire trading World by the European powers, and the monopoly model, very much in the spirit of to monopoly companies / sive trading rights egime throughout the world. The following frequent granting of exclu Adam Smith's(1776/1976) analysis of an In a country like India or Indonesia, where earlier phase of colonialism, seems to me most of the workforce was(and still is)en sugge gaged in traditional agriculture, it is hard to Consider an imperial power whose in- imagine that the ability to control capital vestors have access to capital at a(first) inflows from abroad gave the imperialists world return of r. Assume that the imperial- much monopsony power over the general from a colony, but that the labor market in capital imported from e. way, the value of ist has exclusive control over trade to and level of wages. Put another urope must have the colony is free. Now suppose, at one been a small fraction of capital in these extreme, that the colony has no capital of its countries as a whole, most of which was own, and no ability to accumulate any Then land. If monopoly control over capital im- capital per worker, x, in the colony can be ports was an important source of colonial chosen by the imperialist, and the entire return differentials, it must have been be income repatriated. Under these conditions, cause only a small part of the colonial labor what value of x is optimal from the view- force was skilled enough to work with im- point of the imperial power, viewed as ported capital in, say, goods manufacturing st But to explore this possibility, et the production function in the obviously need a more refined view of the be y=f(x). Then the monopolist,'s probler nature of human capital than one in which is to choose x so as to maximize five day-laborers equal one engineer Insofar as monopoly control over trade in (5)f(x)-[f(x)-xf(x)]-rx, apital goods important factor in the determination of capital-labor ratios prior to 1945, i do not see any reason to believe it or total production less wage payments at a ceased to be a factor after the political end competitively determined wage less the op- of the colonial age. Monopoly returns are portunity cost of capital. The first-order con- With its emphasis on vestment, mauric f(x)=r-xf"(x), Dobbs (1945)discussion wentieth-century colonials so that the marginal product of capital in the the text than is Smith's. According to Lance Davis an colony is equated to the world return r plus empire was open to firms from any country on compet he derivative of the colony s real wage rate ive terms, which would with respect to capital per worker. It is the this model. Moreover, they do not find rates of return in Imperialist's monopsony power over wages ne British colonies that exceeded European returns for in the colony that is crucial. His optimal similar investments retard capital flows so as See Nancy Stokey(1988)for a model in which high human capital workers do qualitatively different things maintain real wages at artificially low levels. than do low human capital workers
AEA PA PERS AND PROCEEDINGS MAY1990 not of interest to Europeans only. There is man capital surely have a much larger poten much unsystematic evidence of heavy private tial. So too, I think, do policies in which aid taxation of capital inflows in Indonesia, the of any form is tied to the recipient's open- Phillipines, in the Iran of the Shah, and ness to foreign investment on competitive other poor economies that are otherwise at- terms. tractive to foreign investors. Restrictions on capital flows imposed by the borrowing country are often explained as arising from REFERENCES mistrust of foreigners or a reluctance to let development proceed"too fast, "but I think Davis, Lance E. and Huttenback, Robert A, such explanations warrant a Smithian skep Businessmen, the Raj, and the Pattern of tis Government Expenditures: The British mpire, 1860 to 1912, " in David W. Galenson, ed, Markets in History, Cam bridge: Cambridge University Press, 1989 Why does it matter which combination, Denison, Edward F, The Sources of economic if any, of the four hypotheses I have ad Growth in the United States. New York: vanced is adequate to account for the ab Committee for Economic Development, sence of income equalizing international ca 1962. ital flows? The central idea of virtually all Dobb, Maurice, Political Economy and Capi- postwar development policies is to stimulate talism, Westport: Greenwood, 1945 transfers of capital goods from rich to poor Krue" capita income Differences Among Anne O"Factor Endowments and countries. Insofar as either of the human capital-based hypotheses reviewed in Sec Countries, Economic Journal, September tions I and II of this paper is accurate, such 1968,78,641-59 transfers will be fully offset by reductions in Lucas, Robert E,, Jr, On the Mechanics of private foreign investment in the poor coun- Economic det lopment, " Journal of Mon try, by increases in that country's invest etary Economics, January 1988, 22, 3-32 ments abroad or both. Insofar as returns on Romer, Paul M-, " Increasing Returns and capital are not equalized, but where return Long-Run Growth, Journal of Political differentials are maintained so as to secure Economy, October 1986, 94, 1002-37 monopoly rents, capital transfers to poor Smith, Adam, The Wealth of Nations, Chicago ountries will also be fully offset by reduc- University of Chicago Press, 1976 tions in private investments. Giving goods to Stokey, Nancy Lo, "Learning by Doing and a monopolist does not reduce his interest in the Introduction of New Goods, Journal exploiting potential rents of political Economy, August 1988, 96 Only insofar as political risk is an impor 701-17 tant factor in limiting capital flows can we Summers, Robert and Heston, Alan, "A New Set expect transfers of capital to speed the inter- of International Comparisons of Real national equalization of factor prices. In a Product and Price Levels: Estimates for world of largely immobile labor, policies fo- 130 Countries, 1950-1985, Review of In- cused on affecting the accumulation of hu come and Wealth, March 1988. 34.1-2
