The magnitude and the direction of net international capital flows does not fit neo-classical models. The 50 U.S. states comprise an integrated capital market with very
low barriers to capital flows, which makes them an ideal testing ground for neoclassical
models. We develop a simple frictionless open economy model with perfectly diversified
ownership of capital and find that capital flows between the U.S. states are consistent
with the model. Therefore, the small size and "wrong" direction of net international
capital flows are likely due to frictions associated with national borders and not due
to inherent flaws in the neoclassical model.
We study the determinants of net capital income flows within the United States. We analyze a simple multi-state neoclassical model in which total factor productivity varies across states and over time and capital flows freely across state borders. The model predicts that capital will flow to states with relatively high output growth. Since relative growth patterns are persistent such states are also high output states, which implies that high output will be associated with inflows of capital and net outflows of capital income. Our empirical findings correspond well to the predictions of the model and indicate persistent net capital income flows and net cross- state investment positions between states which are an order of magnitude larger than observed capital income flows between countries. Thus, our results imply that frictions associated with national borders are likely to be the main explanation for "low" international capital flows.
capital flows, ownership, net factor income, historical income
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