Thursday, 30 October 2008

A twin to Feldstein-Horioka?

The Feldstein-Horioka paradox is that savings rates and investment rates in a country tend to be correlated even if the country has totally open borders for capital flows. One would expect capital to move to where the highest rates of return are, so why should there be a strong relation between national savings and investment in the country? The debate was active in the 1980s, and various papers have explained it to a degree, but I do not know whether it was ever fully answered or people just moved on leaving it incompletely resolved.

I recently came across an analogous empirical observation in open economy macroeconomics, where international exporters tend to price their goods in foreign currency when exporting. It is not obvious whether they would do so, as they may prefer to price in their own domestic currency and accept fluctuations in demand rather than fluctuations in exchange rate returns from foreign currency pricing, and there has been some theoretical debate as to which would be more logical. Published empirical observation indicates, as it does with Feldstein-Horioka, that national considerations predominate and foreign currency pricing applies.

The evidence is preliminary, but still fascinating in terms of describing the continued importance of the nation state, which often works uneasily with capitalism's operation.

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