Pecking%20order%20of%20international%20Capital%20Flows

1
Pecking order of international Capital Flows

• Assaf Razin and Efraim Sadka

2
F(K0)
Owners make investment rule
FDIors step in
realizes
K
Second period
First period
Stage 1 planning
Stage 2 implementation
Managers make finance and investment decision
3
Rigid investment rule dictates the manager to
take either one of three possible courses of
action, once becomes known to her

• Portfolio-equity finance new capital investment,
  so as to augment the stock of capital to a
  predetermined level of KE
• Not to invest at all
• Debt-finance new capital investment, so as to
  augment the stock of capital of the firm to a
  predetermined level of KD .

4
Foreign Direct Investment

• At the end of the planning stage, when is not
  yet known, FDI investors step in. Employing their
  skimming technology they can outbid all other
  investors for the top productivity firms.
• Owners of a firm do not know the productivity
  level. But she can infer from the signal that her
  firm was raided, belong to the top group.

5
Foreign Direct Investment
6
Portfolio Equity Flows
7
Debt Flows
8
Which firms do not make new investment?
9
The capital flows structure of the economy

• There are low productivity firms which finance
  their investment by equity
• There are medium-low productivity
  firms which do not invest
• There are medium-high
  productivity firms which finance their new
  investment by debt issue
• There are high productivity firms,
  pre-screen by foreign direct investors, and sold
  to them.

10
The Investment Rule
11
Determinants of Capital Flows
12
Gains from FDI
13
Constrained Efficiency