Working Paper Series no. 212: Domestic Savings and Foreign Capital: the Complementarity Channel

Abstract

Recent empirical work has shown that current account deficits have been associated with lower growth in developing countries while they have been associated with higher growth in developed countries. This paper shows that this can be rationalized in an environment where firms face (i) transaction costs on the capital market and (ii) complementarity between domestic and foreign sources of capital. In this case, larger current account deficits are associated with lower investment and lower growth. However, the positive relationship between current account balance and growth is dampened with lower transaction costs and eventually gets reversed.

Enisse Kharroubi
April 2008

Classification JEL : D82, E44, F36, G15, G21, O16.

Keywords : Financial Integration, Borrowing Constraint, Growth, Domestic Savings.