You write:
"Thanks Doug, Christian, Carrol, Ulhas, and others. Empirically the data seems to suggest that the return on capital is lower in developing countries. I would expect it to be higher. My reasons:
1) Many developing countries have current account deficits which would imply accommodating capital account inflows...of course if everything freely flows."
dlaw: I would consider whether the leakage of 3rd world savings into other currencies depresses the market for capital goods.
"2) A suppressed supply of capital in a country would push up the rate of return...of course if demand is also suppressed the effect on the rate would depend on the magnitudes."
dlaw: A supressed capital supply only increases risk, not return as such. Capitalists can and do use proven political methods to decrease this risk (cronyism, corruption, various strongarm tactics) rather than more difficult economic strategies to increase return (after all, if increasing returns was easy...).
"3) A standard "increasing at a decreasing rate" production function suggests a lower marginal rate (slope of the function) at lower levels of capital."
dlaw: I think that rather than "increasing at a decreasing rate," one should say "increasing at an increasing rate of uncertainty" (or "volatility" if you want to be Black-Scholes about it).
You write:
"I think part of the problem here is how does one measure the "return" on capital and what is the meaning of "return" to investors. In the real world, return is not the only factor that influences investment, "risk" also plays a role and then there is the matter of the exchange rate during the investment period. So the return in developing countries may be quite high relative to the return in developed countries but when the rate of depreciation of the currency and risk factors associated with political instability, budget deficits, and such are brought in, the "return" may finally be relatively lower. Then perhaps we should be asking what does the data reflect: a) "return" or b) "return + currency depreciation - political instability -...-"?"
dlaw: Of course you can never look at return at the factory door. It has to be measured in cash flow and even then in a flow of a standard kind of cash - dollars, really, maybe euros, pounds or Swiss francs.
You continue:
"Also, another thought is that the aggregate production function in developing countries may be very different from what we assume it to be. If it's actually increasing at an increasing rate then marginal rates would be lower at lower levels of capital."
dlaw: Or uncertainty/volatility may increase more rapidly than in the 1st world, meaning capitalists will accept low returns for low risk.