International capital flows have increased dramatically since the 1980s. During the 1990s gross capital flows between industrial countries rose by 300 per cent, while trade flows increased by 63 percent and real GDP by a comparatively modest 26 percent. Much of the increase in capital flows is due to trade in equity and debt markets, with the result that the international pattern of asset ownership looks very different today than it did a decade ago.
These developments are often attributed to the increased integration of world financial markets. Easier access to foreign financial markets, so the story goes, has led to the changing pattern of asset ownership as investors have sought to realize the benefits from international diversification. It is much less clear how the growth in the size and volatility of capital flows fits into this story. If the benefits of diversification were well-known, the integration of debt and equity markets should have been accompanied by a short period of large capital flows as investors re-allocated their portfolios towards foreign debt and equity.
After this adjustment period is over, there seems little reason to suspect that international portfolio flows will be either large or volatile. With this perspective, the prolonged increase in the size and volatility of capital flows we observe suggests that the adjustment to greater financial integration is taking a very long time, or that integration has little to do with the recent behavior of capital flows.