Recent growth theory emphasizes the contributions of capital mobility and taxation to observed cross-country diversity in long-run growth. In Discussion Paper No. 794, Research Fellow Assaf Razin and Chi-Wa Yuen confront their earlier theoretical findings with data and observed facts. They note that if long-term growth of total GDP under perfect capital mobility is equal across countries, long-term population and per capita income growth will be negatively correlated, and growth rates will exhibit less variation for total than for per capita income. Data on 120 countries listed in the 1989 World Development Report for 1965-87 broadly confirm both results.

Razin and Yuen then consider the proposition that the source principle is `growth-equalizing' under asymmetric capital income taxation whereas the residence principle is `growth-diverging'. Capital income tax rates differ and the residence principle is much the more popular, so this may account for differences in per capita income growth. They quantify the allocative and growth effects of capital mobility and international taxation by calibrating an open economy growth model to `two-country' G7 (US and non-US) data for 1965-87.

Their simulations of various tax reforms and restrictions on long-term resource allocation and growth rates reveal that capital liberalization narrows cross-country differentials in growth rates and returns to physical capital, but its long-run effects are small. Eliminating capital mobility enhances diversity in growth rates and returns to physical capital, causes pre-tax rates of return to diverge, and enhances growth divergence of population and per capita and total incomes. Capital mobility magnifies the growth effects of tax changes enormously: a 0.004% change in the tax rate on capital income under perfect capital mobility approximates the growth effect of a 1% change with capital controls. Recent growth literature may have substantially underestimated potential growth effects by not taking proper account of tax changes and international policy spillovers.

Convergence in Growth Rates: A Quantitative Assessment of the Role of Capital Mobility and International Taxation
Assaf Razin and Chi-Wa Yuen

Discussion Paper No. 794, June 1993 (IM)