Feldstein–Horioka puzzle

The Feldstein–Horioka puzzle is a widely discussed problem in macroeconomics and international finance, which was first documented by Martin Feldstein and Charles Horioka in a 1980 paper. Economic theory assumes that if investors can easily invest anywhere in the world, acting rationally they would invest in countries offering the highest return per unit of investment. This would drive up the price of the investment until the return across different countries is similar. The Feldstein–Horioka puzzle is a widely discussed problem in macroeconomics and international finance, which was first documented by Martin Feldstein and Charles Horioka in a 1980 paper. Economic theory assumes that if investors can easily invest anywhere in the world, acting rationally they would invest in countries offering the highest return per unit of investment. This would drive up the price of the investment until the return across different countries is similar. The discussion stems from the economic theory that capital flows act to equalize marginal product of capital across nations. In other words, money flows from lower to higher marginal products until the increased investment equalises the return with that obtainable elsewhere. According to standard economic theory, in the absence of regulation in international financial markets, the savings of any country would flow to countries with the most productive investment opportunities. Therefore, domestic saving rates would be uncorrelated with domestic investment rates. This is the same fundamental insight which underlies several other results in economics like the Fisher separation theorem.