【ADB】Financial Development and the Capital Flow Allocation Puzzle in Developing Asia

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ADBI Working Paper Series

FINANCIAL DEVELOPMENT

AND THE NET CAPITAL FLOWS

ALLOCATION PUZZLE

IN DEVELOPING ASIA

John Beirne and Pradeep Panthi

No. 1445

April 2024

Asian Development Bank Institute

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The Working Paper series is a continuation of the formerly named Discussion Paper series;

the numbering of the papers continued without interruption or change. ADBI’s working papers

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Suggested citation:

Beirne, J. and P. Panthi. 2024. Financial Development and the Capital Flow Allocation Puzzle

in Developing Asia. ADBI Working Paper 1445. Tokyo: Asian Development Bank Institute.

Available: https://doi.org/10.56506/NHTQ8292

Please contact the authors for information about this paper.

Email: jbeirne@adb.org, ppanthi@adbi.org

John Beirne is a principal economist at the Asian Development Bank (ADB), Manila,

Philippines. Pradeep Panthi is a research associate at the ADB Institute, Tokyo, Japan.

The views expressed in this paper are the views of the author and do not necessarily reflect

the views or policies of ADBI, ADB, its Board of Directors, or the governments they

represent. ADBI does not guarantee the accuracy of the data included in this paper and

accepts no responsibility for any consequences of their use. Terminology used may not

necessarily be consistent with ADB official terms.

Discussion papers are subject to formal revision and correction before they are finalized

and considered published.

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ADBI Working Paper 1445 Beirne and Panthi

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Abstract

Using a panel regression approach across 13 developing Asian economies from 1996Q1 to

2019Q4, this paper examines the extent of financial development as a transmission channel

for mediating the “allocation puzzle” in capital flows. This puzzle pertains to why capital seems

to flow to economies with lower rather than higher productivity growth. We find that while

portfolio equity and debt investment flows are negatively related to total factor productivity

(TFP) in developing Asia, thereby contradicting the predictions of traditional neoclassical

growth models, financial development significantly mitigates this effect. This is particularly the

case at earlier stages of financial development and convergence towards a frontier. For foreign

direct investment, although we find that there is no direct allocation puzzle in developing Asia,

financial development can hamper the stimulatory effect of TFP for highly financially

developed economies given diminishing marginal returns.

Keywords: international capital flows, total factor productivity, financial development,

developing Asia

JEL Classification: F20, F30, F41

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