STEG Working Paper

Structural Change, Inequality, and Capital Flows

Florian Trouvain

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High saving rates in fast growing “miracle” economies and the associated capital outflows have long been a puzzle in the international economics literature. I provide evidence that the demand for safe assets is systematically higher for urban (non-agricultural) relative to rural (agricultural) households suggesting a strong precautionary savings motive in urban areas. I combine this with the insight that miracle economies display fast structural change out of traditional farming. The interplay of structural change and rising demand of safe assets of urban households can account for the puzzling capital outflows during the growth miracle. I then develop a tractable model of miracle growth and human capital risk that rationalizes these findings. The key ingredients of the model are structural transformation away from traditional agricultural production, a heterogeneous income growth experience of households in the urban sector, and initial uncertainty about a household’s success in the urban economy. The model characterizes in closed form the trade-off between consumption smoothing and precautionary savings, and offers a simple sufficient statistic to sign the direction of capital flows along the transition path.

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