CAPITAL FLOWING INTO RICH COUNTRIES.

CAPITAL FLOWING INTO RICH COUNTRIES. I often see comments that there is something unnatural about capital flows from emerging economies to developed countries. For example, the following is from The Economist of September 14, 2006 (from a file I used to maintain of things I would blog about if I had a blog). “The flow of capital from poor countries to the richest economy in the world is exactly the opposite of what economic theory would predict. According to the textbooks, capital should flow from rich countries with abundant capital, such as America, to poorer ones, such as China, where capital is relatively scarce, so returns are higher…… It seems perverse that poor countries today prefer to buy low-yielding American government bonds when they could earn higher returns by investing in their own economies.” I think this view does not take into account the position of an investor in an emerging economy. For such an investor, stocks and bonds of developed countries must seem very attractive, if only for diversification. Investments in emerging countries tend to be high risk and a local investor is probably already exposed to country risk. Investors outside the country are better positioned to bear that risk.