Does institutional quality resolve the Lucas Paradox?

Muhammad Akhtaruzzaman, Christopher Hajzler and Dorian Owen
Additional contact information
Muhammad Akhtaruzzaman: Toi Ohomai Institute of Technology, Rotorua, New Zealand

No 1611, Working Papers from University of Otago, Department of Economics

Abstract: The Lucas Paradox observes that capital flows predominantly to relatively rich countries, contradicting the neoclassical prediction that it should flow to poorer capital-scarce countries. Alfaro, Kalemli-Ozcan, and Volosovych (2008) (AKV) argue that cross-country variation in institutional quality can fully explain the Paradox, contending that if institutional quality is included in regression models explaining international capital inflows, a country’s level of economic development is no longer statistically significant. We replicate AKV’s results using their cross-sectional IFS capital flow data. Motivated by the importance of conducting inference in statistically adequate models, we focus on misspecification testing of alternative functional forms of their empirical model of capital flows. We show that their resolution of the Paradox relies on inference in a misspecified model. In models that do not fail basic misspecification tests, even though institutional quality is a significant determinant of capital inflows, a country’s level of economic development also remains a significant predictor. The same conclusions are reached using an extended dataset covering more recent IFS international capital flow data, first-differenced capital stock data and additional controls.

Keywords: Lucas Paradox; capital flows; foreign direct investment; institutions; misspecification testing (search for similar items in EconPapers)
JEL-codes: C52 E02 F21 F34 F41 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2016-12, Revised 2016-12
References: Add references at CitEc
Citations:

Downloads: (external link)
https://deptcontrib.otago.ac.nz/economics/otago631038.pdf First version, 2016 (application/pdf)
Our link check indicates that this URL is bad, the error code is: 500 Can't connect to deptcontrib.otago.ac.nz:443 (No such host is known. )

Related works:
Journal Article: Does institutional quality resolve the Lucas Paradox? (2018)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:otg:wpaper:1611

Access Statistics for this paper

More papers in Working Papers from University of Otago, Department of Economics Contact information at EDIRC.
Bibliographic data for series maintained by Janet Bryant ().