Question

Why doesn't capital flow from rich to poor countries? Please write an essay on this issue which consists of two paragraphs. Please mention the theoretical and empirical arguments. Thoroughly explain this.

Answer 1

The low level of capital flow from rich country to poor country can be explained using the Lucas paradox. Most of the poor countries having current account surplus and the rich countries run current account deficit. The capital flows shows the saving behaviour of the country. There is a paradox emerged that there is high saving rates in poor countries and lower savings rate in rich countries. The returns on capital can be calculated through capital to output ratio not with capital labour ratio. The country having lower capital output ratio will have lower rate of return on capital. So the capital flow from countries with high capital output ratio to low capital output ratio. The total factor productivity in rich countries is lower than the poor countries. The poor countries is characterised as high capital productivity. So this will leads to the high flow of resources to the rich country. This crate a contrary. The rich countries which have the lower productivity will not try to export their limited capital to the lower countries.
For example, China having highest capital output ratio, but remain as poor. But China is the largest capital exporter. The capital output ratio is very low in the developed country like US. But US export a small amount of capital to other countries. In poor countries the investment rate is greater than the saving rate. At the same time, there is scarcity of investment in the developed countries like US. So Lucas explained this controversy using the Lucas paradox. Most of the poor countries are richer on the basis of their resource availability. This will increase the saving and investment rate. But on the other side, there is a low saving and investment rate in the developed country like US. So they will not encourage unlimited, low productivity capital to the poor countries.