Capital heterogeneity, entrepreneurship and two-way capital flows

Abstract

This paper examines the drivers of two-way capital flow phenomenon in various developing countries where flows of portfolio investment and direct investment through borders prove contradictory directions. We try to claim that the scarcity of entrepreneurs in fewer developed countries, who improve firm productivity across unobservable (and thus not contractible) entrepreneurship effort, is an essential resource of two-way capital flows. Building upon the context of venture capital studies, this paper describes in a straightforward model that the lack of entrepreneurs would leave some domestic investment opportunities forgone, following in lower investment, lower interest rate, and lower savings compared optimality. Allowing foreign entrepreneurs to raise money from domestic financial market in the form of portfolio investment outflow and then to invest in the domestic firms in the form of direct investment inflow would help alleviate the situation. In this regard, two-way capital flows bring domestic economy benefit of learning through opening-up.