Serial Default and the “Paradox” of Rich-to-Poor Capital Flows

Lucas (1990) argued that it was a paradox that more capital does not flow from rich countries to poor countries. He rejected the standard explanation of expropriation risk argued that paucity of capital flows to poor countries must instead be rooted in externalities in human capital formation favoring further investment in already capital countries. In this paper, we review the various explanations offered for this “paradox.” There is no doubt that there are many reasons why capital does not flow rich to poor nations – yet the evidence we present suggests some explanations are more relevant than others. In particular, as long as the odds of non repayment are as as 65 percent for some low income countries, credit risk seems like a far more compelling reason for the paucity of rich-poor capital flows. The true paradox may not that too little capital flows from the wealthy to the poor nations, but that too much capital (especially debt) is channeled to “debt intolerant” serial defaulters.