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The Review of Economics and Statistics Vol. 90 No. 2 2008

Why Doesn't Capital Flow from Rich to Poor Countries? An Empirical Investigation

Laura Alfaro1; Şebnem Kalemli-Özcan; Vadym Volosovych2

1 Harvard Business School, Business, Government, and the International Economy Unit · 2 Florida Atlantic University

Abstract

We examine the empirical role of different explanations for the lack of capital flows from rich to poor countries—the “Lucas Paradox.” The theoretical explanations include cross-country differences in fundamentals affecting productivity, and capital market imperfections. We show that during 1970–2000, low institutional quality is the leading explanation. Improving Peru's institutional quality to Australia's level implies a quadrupling of foreign investment. Recent studies emphasize the role of institutions for achieving higher levels of income but remain silent on the specific mechanisms. Our results indicate that foreign investment might be a channel through which institutions affect long-run development.

DOI
10.1162/rest.90.2.347
Volume
90
Issue
2
Pages
347-368
Language
en
Sources
crossref openalex

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