A note on capital mobility.

• Author: Moosa, Imad A.

1. Introduction

   Empirical work on capital mobility, using the Feldstein-Horioka [5] saving-investment correlation as a measurement criterion has generally produced two results. The first result is that even when the econometric problems (particularly the endogeniety of domestic saving) are addressed, the Feldstein-Horioka finding of low capital mobility seems to hold up [7, 1084]. The second result is that the surprising finding of low capital mobility is obtained even if the data set extends well into the 1990s as was found by, inter alia, Dar, Amirkhalkhali, and Amirkhalkhali [4]. This finding is not consistent with the conventional wisdom that capital mobility has increased at an accelerating rate since the early 1970s. For example, Frankel and MacArthur [7, 1084] list the following stylized facts: (i) the degree of capital mobility is high; (ii) it is higher for industrial countries; and (iii) it has been rising since the 1950s and particularly since 1973.(1) The saving-investment correlation as a criterion does not only indicate that the degree of capital mobility is low across the board, but also fails to show that it has been increasing over time, thus refuting the stylized facts (i), (ii) and (iii).

   Economists have for long recognised the contradiction between the casual-observation-based conventional wisdom that capital mobility has reached a high level and the empirical evidence which indicates the contrary. It seems, however, that this contradiction is due to a combination of conceptual, methodological and econometric issues. The objective of this note is to shed some light on these issues and to present empirical evidence on capital mobility based on real interest parity.

2. Some Conceptual and Methodological Issues

   The literature on capital mobility and market integration seems to have traces of ambiguity, confusion and lack of clarity, leading to contradictory conclusions. Frankel [6, 27] makes this point clear by asserting that "the aggregation together of all forms of capital has caused more than the usual amount of confusion in the literature on international capital mobility." It is possibly the case that economists reaching the opposite conclusions about capital mobility might refer to different things i.e., different concepts and measurements of capital. For example, the word "capital" may imply "micro" as opposed to "macro" capital, "net" as opposed to "gross" capital, "portfolio" as opposed to "physical" capital,(2) and "short-term" as opposed to "long-term" capital. Furthermore, it is not really clear whether or not economists regard capital mobility and market integration as the same thing or if one is a necessary condition for the other.

   It may be the case that the controversy raised by the Feldstein-Horioka work is due to their use of capital mobility in a macroeconomic sense whereas most of the studies are based on capital in a microeconomic sense. And while capital moves in all directions, it could be the case that net capital flows are not significant, and that it is net capital movements which Feldstein and Horioka were concerned with. This is because net capital flows, which constitute the financial counterpart to the transfer of real resources through payment imbalances, arise only when saving and investment are not matched within individual countries. On the other hand, gross capital flows can be mutually offsetting across countries.

   In this note we are concerned with financial or portfolio (gross) capital flows. An issue that needs some clarification is the relationship between capital mobility and market integration, two concepts that are often used interchangeably. A careful reading of the literature, as manifested by Goldstein, Mathieson, and Lane [8] and Frankel [6], leads to the following propositions:

   1. Macroeconomic capital mobility is not a necessary condition for market integration.

   2. Equalization of real interest rates across countries is not a necessary condition for market integration.(3)

   3. Market integration is conducive to capital mobility, or at least it leads to increasing "potential" capital flows.(4)

   4. Capital mobility is a sufficient condition for market integration, or at least that a high level of capital mobility indicates a high level of market integration.

   5. Equalization of real interest rates does not preclude the effect of a shortfall in domestic saving on domestic investment projects.

   The literature also reveals a diversified menu of measurement criteria. Apart from the saving-investment correlation, capital mobility and market integration can be measured by deviations from the...