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The Feldstein–Horioka Puzzle or Paradox after 44 years: a fallacy of composition

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  • Charles Yuji Horioka

    (Kobe University
    Asian Growth Research Institute
    Osaka University
    University of the Philippines)

Abstract

The finding of Feldstein and Horioka (1980) that domestic saving and domestic investment are highly correlated across countries despite the rapid globalization and liberalization of financial markets in recent decades has been regarded as a Puzzle or Paradox. However, in this paper, we show that countries as a whole may not be able to transfer their capital abroad and that the Feldstein–Horioka Finding of domestic saving and domestic investment being highly correlated across countries may arise even if there are no frictions in financial markets and even if individual investors can freely transfer their capital abroad if there are frictions in goods markets such as transport costs, tariffs, nontariff barriers, the cost of regulatory compliance, etc. In fact, there is evidence that frictions in goods markets are a more serious impediment to countries as a whole being able to transfer their capital abroad than frictions in financial markets, especially in the short run.

Suggested Citation

  • Charles Yuji Horioka, 2024. "The Feldstein–Horioka Puzzle or Paradox after 44 years: a fallacy of composition," The Japanese Economic Review, Springer, vol. 75(3), pages 383-404, July.
    • Handle: RePEc:spr:jecrev:v:75:y:2024:i:3:d:10.1007_s42973-024-00153-w
    DOI: 10.1007/s42973-024-00153-w
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    1. Charles Yuji Horioka & Nicholas Ford, 2017. "A possible explanation of the ‘Exchange Rate Disconnect Puzzle’: a common solution to three macroeconomic puzzles?," Applied Economics Letters, Taylor & Francis Journals, vol. 24(13), pages 918-922, July.
    2. Charles Yuji Horioka & Akiko Terada-Hagiwara & Takaaki Nomoto, 2016. "Explaining Foreign Holdings of Asia's Debt Securities: The Feldstein–Horioka Paradox Revisited-super-," Asian Economic Journal, East Asian Economic Association, vol. 30(1), pages 3-24, March.
    3. Mariam Camarero & Alejandro Muñoz & Cecilio Tamarit, 2021. "50 Years of Capital Mobility in the Eurozone: Breaking the Feldstein-Horioka Puzzle," Open Economies Review, Springer, vol. 32(5), pages 867-905, November.
    4. Lapp, Susanne, 1996. "The Feldstein-Horioka paradox: A selective survey of the literature," Kiel Working Papers 752, Kiel Institute for the World Economy (IfW Kiel).
    5. Feldstein, Martin & Horioka, Charles, 1980. "Domestic Saving and International Capital Flows," Economic Journal, Royal Economic Society, vol. 90(358), pages 314-329, June.
    6. Charles Yuji Horioka, 2021. "Is the selfish life-cycle model more applicable in Japan and, if so, why? A literature survey," Review of Economics of the Household, Springer, vol. 19(1), pages 157-187, March.
    7. Abdul Abiad & Ashoka Mody, 2005. "Financial Reform: What Shakes It? What Shapes It?," American Economic Review, American Economic Association, vol. 95(1), pages 66-88, March.
    8. Eaton, Jonathan & Kortum, Samuel & Neiman, Brent, 2016. "Obstfeld and Rogoff׳s international macro puzzles: a quantitative assessment," Journal of Economic Dynamics and Control, Elsevier, vol. 72(C), pages 5-23.
    9. Coakley, Jerry & Kulasi, Farida & Smith, Ron, 1998. "The Feldstein-Horioka Puzzle and Capital Mobility: A Review," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 3(2), pages 169-188, April.
    10. Apergis, Nicholas & Tsoumas, Chris, 2009. "A survey of the Feldstein-Horioka puzzle: What has been done and where we stand," Research in Economics, Elsevier, vol. 63(2), pages 64-76, June.
    11. Yasutomi, Ayumu & Horioka, Charles Yuji, 2011. "Adam Smith's answer to the Feldstein-Horioka Paradox: The invisible hand revisited," Economics Letters, Elsevier, vol. 110(1), pages 36-37, January.
    12. Abdul Abiad & Ashoka Mody, 2005. "Financial Reform: What Shakes It? What Shapes It?," American Economic Review, American Economic Association, vol. 95(1), pages 66-88, March.
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    Cited by:

    1. Hiroya Tanaka & Keiichi Hori & Akihisa Shibata, 2024. "Search-for-Yield and Home Bias under Quantitative Easing," KIER Working Papers 1106, Kyoto University, Institute of Economic Research.

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    More about this item

    Keywords

    Capital controls; Fallacy of composition; Feldstein–Horioka Finding; Feldstein–Horioka Puzzle or Paradox; Frictions in financial markets; Frictions in goods markets; Global interest rate; Globalization and liberalization of financial markets; Interest parity; Interest rate equalization; International capital flows; International capital mobility; Saving-investment correlations; Saving retention coefficient; Trade costs; Trade frictions;
    All these keywords.

    JEL classification:

    • F15 - International Economics - - Trade - - - Economic Integration
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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