Barriers to Global Capital Allocation

Title: Barriers to Global Capital Allocation

Speaker: Enrico Spolaore (Tufts University)

Abstract: International portfolios and heterogeneity in the rate of return to capital across countries are hardto reconcile with frictionless capital markets. In this paper, we develop a quantitative theory ofinternational capital allocation: a multi-country dynamic general equilibrium model in which the entirenetwork of cross-border investment is endogenously determined. The model features not only countryheterogeneity in fundamental risk but also, crucially, a rich set of policy and information frictions thatdistort international capital flows. It embeds rationally-inattentive investors and produces closed-formsolutions for international portfolios that follow a logit form. We take the model to the data using aparsimonious (yet easily extensible) set of frictions: capital income taxes, political risk, and measuresof geographic, linguistic, and cultural distance between countries. Our framework accounts well forinternational portfolio patterns, the cross-section of home bias and rates of returns to capital, andother key features of international capital markets. Finally, we perform counterfactual exercises: inparticular, we show that barriers to international investment reduce world output by about 6% andcan account for nearly half of the observed cross-country inequality in capital per employee.