Asymmetric growth effect of capital flows: Evidence and quantitative theory

- While the promised benefits of inflows are vague, capital outflows visibly hurt growth.
- We use the asymmetric Granger causality test to investigate causal evidence.
- We find strong evidence across Asian countries in support of asymmetry.
- Heterogeneous investments and endogenous credit constraints are identified as the mechanisms.
- Long-term but not short-term investment is credit constrained and spurs growth.
- The arbitrage condition embeds a boundary over which capital inflow is irrelevant to growth.
- The endogenous credit constraint makes capital outflows destructive to growth.
- The mechanism survives different levels of financial development.

The empirical evidence of the causal relationship between capital flows and economic growth over the decades is largely indecisive. While the promised benefits to countries that open for capital inflows have not been realized, sudden and massive capital outflows often visibly wreak havoc on the economy. By using the recently developed asymmetric Granger causality test, we find overwhelming evidence across nine selected Asian countries in support of an asymmetric effect of capital flows on economic growth in the sense that cumulative capital inflows are irrelevant to growth, whereas cumulative capital outflows are destructive to growth. Based on a small open economy model expanded with heterogeneous investment goods and endogenous nonlinear credit constraints, we provide an economic intuition for the asymmetry that survives different levels of financial development. In particular, the arbitrage condition between heterogeneous investment goods sets a boundary over which massive and persistent capital inflows have no impact on long-run growth. On the other hand, endogenous nonlinear credit constraints trigger a debt deflation process, making large and persistent capital outflows destructive to growth.