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We examine whether the observed international capital flows between 1960-2000 had any significant impact on output per capita and welfare. We compare observed consumption behavior to a calibrated neoclassical model of consumption under autarky. The welfare loss from autarky is equivalent to a 10% permanent decline in consumption. Expanding our analysis to include potential productivity gains from the inflow of FDI, the predicted welfare loss from autarky goes up by another 2%. Compared to previous literature, these results indicate substantial gains from international financial integration. Finally, performing development accounting on actual output, we show that foreign capital flows can account for approximately 5.6% of variation in log output per capita across a sample of developing countries in 2000.

The literature has shown that the implied welfare gains from international financial integration are very small. We revisit the existing findings and document that welfare gains can be substantial under two scenarios: a) the costs of remaining in autarky are worse than the standard neo-classical model would predict, and b) financial integration has a direct affect on total factor productivity. By estimating the implied path of convergence of rates of return from the actual data and calibrating the welfare gains based on this path, we find that the benefits are nearly 4.3 times larger than the previous estimates. We also find welfare gains are at least 2 times larger than those estimated ignoring the productivity effect. The combined effect of realistic convergence and endogenous productivity as a result of financial integration is equivalent to a nearly 15% permanent increase in consumption.