Why doesn't Capital Flow from Rich to Poor Countries? An Empirical Investigation
Laura Alfaro, Sebnem Kalemli-Ozcan, and Vadym Volosovych ,
( 90 )
The Review of Economics and Statistics

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.

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