Financial integration, capital mobility, and income convergence

Abstract: Recent studies have found that capital moves 'uphill' from poor to rich countries, and brings little or no growth dividend when it does flow into poor economies. This article shows that Europe does not conform to this paradigm. In the European experience of financial integration, capital has flown from rich to poor countries, and such inflows have been associated with significant acceleration of income convergence. Analysing broader samples of countries, the article finds that 'downhill' capital flows tend to be observed above certain thresholds in institutional quality and financial integration. But Europe remains different even when allowing for such threshold effects, and its experience is similar to that of interstate flows within the United States. The findings are consistent with the notion that financial diversification reduces countries' incentives to save in order to self-insure against specific shocks.

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