Abstract

Where does international capital flow? Robert E. Lucas Jr. (1990) asked why capital did not flow from rich countries to poor, implicitly assuming that returns to capital in developing countries were higher than those in the devel oped world. Ohanian and Wright (2008) measured rates of return over the last 50 years to assess whether capital indeed flowed from low return countries to high return countries. We found that capital flows for much of the postWorld War II period are the reverse of the flows predicted by theory. That is, capital has tended to flow to countries with relatively low returns, rather than high returns. This paper analyzes where capital flowed dur ing the “golden era” of international flows from 1880–1913, when capital mobility is considered to have been quite high, and during the interwar period from 1918–1938, when capital flows were increasingly restricted following the First World War and the Great Depression. Following the methodology of our earlier paper, we construct two measures of the level of returns in a country and compare these returns to observed capital flows. The first measure, based on the marginal product of capital, is constructed using a CobbDouglas technology and measured from the observed capital-output ratio. The second measure is based on observed consumption growth, which is the return to capital when consumers have log preferences over consumption, and which otherwise is a good proxy for the return