Financial Development and the Patterns of International Capital Flows

We develop a tractable two-country overlapping-generations model and show that cross-country differences in financial development can explain three recent empirical patterns of international capital fl ows: Financial capital fl ows from relatively poor to relatively rich countries while foreign direct investment flows in the opposite direction; net capital fl ows go from poor to rich countries; despite of its negative net international investment positions, the United States receives a positive net investment income. We also explore the welfare and distributional effects of international capital fl ows and show that the patterns of capital flows may reverse along the convergence process of a developing country.