The Feldstein–Horioka puzzle is a widely discussed problem in macroeconomics and international finance, first documented by Martin Feldstein and Charles Horioka in an 1980 paper.[1] According to economic theory, if we assume that investors that are able to easily invest anywhere in the world, they invest in countries that offer the highest return per unit of investment. Which would drive up the price until the return per unit of investment across different countries is similar. If we believe this is true then statistical data would show no relationship between savings and investment within a single country. However, the data gives evidence of the exact opposite.
The discussion stems from the economic theory that capital flows act to equalize marginal product of capital across nations. In other words, money will flow from lower to higher marginal products until the increased investment lowers the return to the level of the rest of the world. Under this model, a saver in France will have no incentive investing in the French economy, but rather would invest in the economy with the highest productivity return to his capital (the highest marginal productivity of capital). Therefore, increased saving rates within one country need not result in increased investment.
FH argued that if there is perfect capital (K) mobility, we should observe low correlation between domestic investment (I) and savings (S). Investors in one country do not need the funds from domestic savers and can borrow from international markets at world rates. By the same token, savers can lend to foreign investor the entirety of the domestic savings. 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.
If the capital flows between OECD countries are reasonably free, this should hold true for domestic saving and investment rates for those countries. Feldstein and Horioka observed that, for OECD countries, domestic savings rates and domestic investment rates are, instead, highly correlated, in contrast to standard economic theory.
Maurice Obstfeld and Kenneth Rogoff identify this as one of the six major puzzles in international economics.[2] The others are the home bias in trade puzzle, the equity home bias puzzle, the consumption correlations puzzle, the purchasing power and exchange rate disconnect puzzle, and the Baxter–Stockman neutrality of exchange rate regime puzzle.