Increasing Returns, Institutions, and Capital Flows

This paper empirically tests one prominent explanation for why capital has not flowed from the rich to the poor countries: institutions. In contrast to the study by Alfraro, Kalemli-Ozcan, and Volosovych in 2008, institutional quality does not explain the Lucas Paradox. Like them, institutional variables are found to be a very important factor, but in contrast to their findings, initial Gross Domestic Product (GDP) still plays a role in capital flows. In addition, poor countries may have different determinants of capital flows from rich countries. The evidence suggests a threshold income level, where a country receives significantly more capital flows if given a sufficiently high income.