DP5635 | Why Does Capital Flow to Rich States?

Publication Date

11/04/2006

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Abstract

We study the determinants of net capital income flows within the United States. We analyze a simple multi-state neoclassical model in which total factor productivity varies across states and over time and capital flows freely across state borders. The model predicts that capital will flow to states with relatively high output growth. Since relative growth patterns are persistent such states are also high output states, which implies that high output will be associated with inflows of capital and net outflows of capital income. Our empirical findings correspond well to the predictions of the model and indicate persistent net capital income flows and net cross-state investment positions between states which are an order of magnitude larger than observed capital income flows between countries. Thus, our results imply that frictions associated with national borders are likely to be the main explanation for 'low' international capital flows.