According to the Solow growth model, all countries will eventually converge to their long-run steady state. If we consider the usual assumptions, of countries producing the same goods with the same constant returns to scale production technology, using (homogeneous) capital and labor as factors of production, the differences in per capita income will reflect the differences in per capita capital . Therefore, essentially, if capital were allowed to flow freely, new investment would only take place in the poorest economies. However this is certainly not the case in reality. Most net capital flow over the past four decades has occurred from north to north (rich countries invest in other rich countries), rather than from north to south (rich economies invest in poorer ones), as predicted by the model of Solow growth.Lucas (1990) compare the United States and India using 1988 data to demonstrate that capital does not flow from rich to poor countries as predicted by the neoclassical growth model, and in outlining its simple framework illustrates the paradox that exists. Assuming a production function y = Ax^B, the relative marginal productivity of capital (MPK) will be given by: rIndia/ rUS= (yIndia / yUS)^(β -1)/ β. Inserting 1988 data, we find that India's marginal product should be 58 times that of the United States, so all investment should flow from the United States to India. Here lies the paradox: in reality such flows are not observed. The law of diminishing returns implies that the marginal productivity of capital will be higher in poorer countries. If this model is correct and capital markets are free and complete, investments should take place in India and other poor countries, and not in the United States or other richer countries... middle of paper... 11.3. Michael A. Clemens. (2002). Do rich countries invest less in poor countries than in poor countries themselves? Available: www.jstor.com. Last accessed January 20, 2011.4. Jonathan Eaton Mark Gersovitz Joseph E. Stiglitz. (1986). THE PURE THEORY OF COUNTRY RISK. Available: http://www.nber.org/papers/w1894.pdf. Last accessed January 20, 2011.5. Wei, Shang Jin. (2000). Local corruption and global capital flows Commentary and discussion. Available: www.jstor.com. Last accessed January 20, 2011.6. Ays¸e Y. Evrensel. (2004). Lending to developing countries revisited: Changing nature of lenders and payment problems. Available: http://www.sciencedirect.com/science?_ob=MImg&_imagekey=B6W8Y-4DS906V-1-1&_cdi=6667&_user=128590&_pii=S0939362504000615&_origin=search&_coverDate=09/01/2004&_sk=999719996&view=c& =dGLbVzW-zSkWA&md5. Last accessed January 20, 2011.7. Lecture notes