Bad Investments and Missed Opportunities: Capital Flows to Latin America and Asia, 1950-2004

From the end of the Second World War to the beginning of the Twenty-First Century, per-capita GDP in the economies of East Asia grew almost three times as fast as in the economies of Latin America. Specifically, in 1950, the economies of the Asian Tigers (Japan, South Korea, Singapore and Taiwan) had just 17 percent of US per capita GDP, but grew to have 67 percent by 2001. In contrast, Latin America had 28 percent of US per capita GDP in 1950, and and only had 23 percent in 2001. Despite this large growth differential, capital predominantly flowed out of Asia and into Latin America. What caused this apparent gross misallocation of capital? How different would the development process have looked has capital flowed to the region with the highest returns? In this paper, we present a framework for analyzing the incentives facing investors when they choose to allocate capital internationally. Applying the framework to data on the major Asian and Latin American economies, we account for the pattern of observed capital flows. We the use the framework to explore the effect of different policy interventions at different stages in history on capital flows and development.