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Development Strategy and International Capital Flows


Content introduction:


Development Strategy and International Capital Flows


Justin Yifu Lin,Xin Wang 
This version: May 2,2019



The “Lucas Paradox” has triggered an extensive theoretical literature on the determinants of international capital flows between capital-abundant developed and capital scarce developing countries. Few papers have captured the substantial inflow to emerging economies with good economic performance. In this paper, we argue that the direction of capital flows to a developing country is determined by the country’s development strategy. If the government in a labor-abundant country employs a comparative-advantage following strategy to facilitate the development of the labor-intensive sector, the economic performance will be good and capital return will be high. The country will attract capital inflows. If instead, the government, influenced by inappropriate development ideas, adopts a comparative-advantage-defying strategy to favor the development of the capital intensive sector with various interventions, the economic performance will be poor and capital return will be repressed. As a result, the capital outflow will happen, as described by Lucas Paradox. We develop a simple static model to formalize this idea and test the hypothesis with a comprehensive data set.


JEL Codes: F21; F41; L16; O11; O25


Key Words: comparative advantage, international capital flows, development strategy, industrial structure, financial repression