from the developing economies and its implications for the global economy. one approach to explaining the uphill flow of capital focuses on divergent patterns of growth and investment. according to one such view, the rise in u. s. productivity growth since the mid - 1990s boosted perceived rates of return on u. s. assets and thus attracted capital ; expectations of higher rates of return and higher incomes likely boosted u. s. investment and consumption spending as well ( erceg, guerrieri, and gust, 2006 ; ferguson, 2005 ). a complementary explanation, labeled the " global saving glut " by federal reserve chairman bernanke several years ago, argues that during the past decade, declines in investment spending outside the united states – in part because of emergingmarket crises – led to a surplus of saving over investment abroad that was channeled toward the u. s. economy ( bernanke, 2005 ; gruber and kamin, forthcoming ). the global saving glut argument suggests that developing economies have benefited from the recent pattern of global capital flows, gaining both demand for their products and a safe return on their assets at a time when an investment slump threatened to depress domestic activity and rates of return. the implications of the u. s. productivity story are a little harder to read, but developing economies, especially in asia, likely have benefited from the expansion of investment and production opportunities created by the revolution in information technology. neither the global saving glut nor the u. s. advantage in productivity growth, however, can be expected to persist indefinitely. how long the differences will persist depends upon a number of factors. in rapidly developing countries that have had high savings rates such as china, for example, consumption demand is likely to increase as they grow wealthier, thereby reducing their savings rates. concerning productivity differences, it may require more than simply the diffusion and adoption of information technology around the globe. as i will come back to later, flexible labor, product, and financial markets appear to be crucial to reaping the full benefits of the information technology revolution, so national policy choices will play an important role in maintaining or closing productivity differences. in any event, this set of explanations for the uphill flow of capital suggests that it would be likely and desirable for net capital flows to reverse direction and head back toward the developing economies at some point. a second – but not mutually exclusive – set of explanations for this phenomenon focuses on what might be more - persistent, structural

even less mature than they are today. that said, the financial - sector stories as well as the productivity stories i've reviewed probably are at least part of the explanation for the global pattern of capital flows. moreover, these stories help to identify policies that developing economies can undertake to boost domestic capital formation and enhance the attractiveness of financial assets, both for foreign and domestic investors. such policies lay the foundation for future economic growth as well as promise to alter the current pattern of capital flows and external balances. elaborations on the role of fiscal policy in the u. s. current account deficit are in cline ( 2005 ) and chinn ( 2005 ). making emerging - market economies a more attractive place to invest businesses in many emerging - market economies face a multitude of hurdles. red tape, rigid regulations, and weak legal systems impede the formation of businesses, their ongoing operation, and their confidence in having their contracts enforced without long and costly litigation. accordingly, governments in these countries could greatly improve the environment for domestic capital formation by simplifying business regulations, strengthening property rights, including the rights of creditors, and improving contract enforcement ( kroszner 2003 and 2006b ; mishkin, 2006 ). these kinds of institutional improvements would also help ensure that capital inflows are channeled in a growthenhancing manner ( arteta, eichengreen, and wyplosz, 2003 ). as noted above, i believe it will take more than simply investment in information technology ( it ) for a country to enjoy the large productivity enhancements that can be brought about by the it revolution ( kroszner 2003 and 2006b ). the it revolution has not simply allowed a worker to turn the crank faster on an improved machine ( the traditional way we think of technological innovation ) but opened the possibility of fundamentally altering the way production ( or provision of a service ) takes place. in this way, it can contribute larger productivity improvements when an economy has flexible labor, product, and financial markets. to provide the greatest incentive for investment in the context of the it revolution, business must operate in an environment that will permit them to transform themselves in ways that allow technologyintensive investment to have the highest possible effect on productivity growth. similarly, labor markets must be flexible enough to allow for the prompt re - allocation of resources in response to changes in demand. the economy also must be competitive enough to allow useful innovations at some firms to be transmitted throughout the