11/20/2001 1 Capital Flows and Economywide Modeling David Roland-Holst † Overview Financial flows generally, and foreign capital flows in particular, have been one of the more challenging areas for CGE modelers. These flows are important to the underlying economies, particularly developing ones where FDI and other external inflows can exert significant leverage on the growth process and domestic institutions. Despite general agreement about what kind of phenomena deserve primary attention and a wide variety of strategies to capture them, however, modelers have failed to attain consensus about empirically robust specifications. There are substantive reasons for this failure, but perhaps a more modest agenda and greater dialogue can improve this situation. Why this is difficult: Like most other components of our models, a structural specification of financial behavior is only as credible as the economic theory it represents. We know money is important in economics, but it has defied conclusive integration into general equilibrium theory. One could quote the Old Masters endlessly on this, beginning with Walras himself, but challenges emerge clearly in today’s work [1, 3, 6, 11, 12, 16, 18, and 24]. What we want to explain: Money and finance at the micro and macro levels encompass a vast range of phenomena and behavior, but for present discussion it makes sense to set priorities. Since the main emphases of the conference are trade and development, I recommend examination of issues in two groups: High Priority • Foreign Direct Investment – This really refers to long term real investment, which is important because of its real growth effects and which, being linked to real rates of return, might be more amenable to neoclassical specification. • Remittances – a very important emergent issue in multilateral capital flows, particularly in the Americas. Also driven by real economic variables, but of a very different kind (see e.g. http://www.iadb.org/mif/website/static/en/remit.asp ). Lesser Priority • Debt and Debt Service – not insignificant, particularly in the sovereign case, but less amenable to market forces and endogeniety. • Hot Money – probably a waste of time for long term real growth modeling † Handout prepared for the international symposium on “Impacts of Trade Liberalization Agreements on Latin America and the Caribbean,” sponsored by the Inter-American Development Bank and the Centre d’Etudes Prospectives et d’Information Internationales, November 5-6, Inter-American Development Bank, Washington, D.C. David Roland-Holst is the James Irvine Professor of Economics at Mills College, Oakland, CA, 94613. Email: dwrh@mills.edu