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Channeling Domestic Savings into Productive Investment Under Asymmetric Information: The Essential Role of Foreign Direct Investment

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  • Assaf Razin
  • Efraim Sadka
  • Chi-Wa Yuen

Abstract

Foreign direct investment (FDI) is observed to be a predominant form of capital flows to low and middle income countries with insufficiently developed capital markets. This paper analyzes the problem of channeling domestic savings into productive investment in the presence of asymmetric information between the managing owners of firms and other portfolio stakeholders. We emphasize the crucial role played by FDI in sustaining equity-financed capital investment for economies plagued by such information problems. Similar problems also exist for foreign portfolio debt flows. The paper identifies how, in the presence of information asymmetry, different capital market structures may lead to foreign over- or under-investment and to domestic under- or over-saving, and thus to inefficient equilibria. We show how corrective tax-subsidy policies consisting of taxes on corporate income and the capital incomes of both residents and nonresidents can restore efficiency.

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  • Assaf Razin & Efraim Sadka & Chi-Wa Yuen, 1997. "Channeling Domestic Savings into Productive Investment Under Asymmetric Information: The Essential Role of Foreign Direct Investment," NBER Working Papers 6338, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:6338
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    1. Razin, Assaf & Sadka, Efraim & Yuen, Chi-Wa, 1998. "A pecking order of capital inflows and international tax principles," Journal of International Economics, Elsevier, vol. 44(1), pages 45-68, February.
    2. Gordon, Roger H & Bovenberg, A Lans, 1996. "Why Is Capital So Immobile Internationally? Possible Explanations and Implications for Capital Income Taxation," American Economic Review, American Economic Association, vol. 86(5), pages 1057-1075, December.
    3. George A. Akerlof, 1970. "The Market for "Lemons": Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 84(3), pages 488-500.
    4. Jacob Frenkel & Assaf Razin & Efraim Sadka, 1991. "International Taxation in an Integrated World," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061430, April.
    5. Zhaohui Chen & Mr. Mohsin S. Khan, 1997. "Patterns of Capital Flows to Emerging Markets: A Theoretical Perspective," IMF Working Papers 1997/013, International Monetary Fund.
    6. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
    7. Bester, Helmut, 1985. "Screening vs. Rationing in Credit Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 75(4), pages 850-855, September.
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    1. Assaf Razin & Efraim Sadka & Chi-Wa Yuen, "undated". "Quantitative Implications of the Home Bias: Foreign Underinvestment, Domestic Oversaving, and Corrective Taxation," EPRU Working Paper Series 97-27, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
    2. Diemo Dietrich, 2004. "Financing FDI into Developing Economies and the International Transmission of Business Cycle Fluctuations," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 140(IV), pages 449-481, December.
    3. Assaf Razin & Efraim Sadka & Chi-Wa Yuen, 2001. "Why International Equity Inflows to Emerging Markets are Inefficient and Small Relative to International Debt Flows," NBER Working Papers 8659, National Bureau of Economic Research, Inc.
    4. Diemo Dietrich, 2004. "Financing FDI into Developing Economies and the International Transmission of Business Cycle Fluctuations," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 140(IV), pages 449-481, December.
    5. Mariano Bosch & Angel Melguizo & Ximena Peña & David Tuesta, 2015. "Savings under formal and informal conditions," Working Papers 1519, BBVA Bank, Economic Research Department.
    6. Assaf Razin & Efraim Sadka & Chi-Wa Yuen, 1998. "Capital Flows with Debt-And Equity-Financed Invesment: Equilibrium Structure and Efficiency Implications," CEMA Working Papers: Serie Documentos de Trabajo. 136, Universidad del CEMA.
    7. Mariano Bosch & Angel Melguizo & Ximena Peña & David Tuesta, 2015. "El ahorro en condiciones formales e informales," Working Papers 1523, BBVA Bank, Economic Research Department.
    8. repec:zbw:iwhdps:165 is not listed on IDEAS

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    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements

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