Development and capital flow mysteries

There are significant per capita income differences between countries. Since additional capital is more productive in firms and countries with low capital levels, standard theory predicts that poor countries should receive investments as a matter of priority. Nevertheless, capital flows from poor to rich countries, which constitutes a serious challenge to standard economic theory. Extensions to standard theory have been considered, such as considering countries’ human capital qualities or financial development levels. Investors could, for instance, fear expropriation in poor countries and prefer lower but safer returns at home. The result is that both education and credit market imperfections help explain why capital does not flow from rich to poor countries, but theory still lacks something. Economic science must step up before it can make reliable economic development policy recommendations. Still, inaction would be worse, and incomplete scientific knowledge can be helpful in designing policy. While better financial institutions and education systems might both stimulate growth, these are not sure recipes for successful development. Policy-makers are invited into economists’ kitchens.