Estimating the Determinants of Capital Inflows Using Cross Sectional Data

Abstract

This chapter re-investigates the empirical studies claimed for a solution to the Lucas paradox using cross-sectional regression analysis with new specifications of the conditional mean capital inflow function. By replicating a closely related empirical work (Alfaro et al. 2008), this empirical chapter shows that differences in institutional quality (e.g., property rights) between rich and poor countries are not sufficient to explain fully why such large capital flows are observed flowing from poor to rich countries. This finding implies that, when the empirical model is specified more appropriately, differences in institutional quality cannot fully explain why capital flows to rich countries. This chapter confirms this finding using an updated dataset on capital inflows covering the most recent decade. This updated analysis shows that institutional quality alone does not solve the Lucas paradox because capital is still observed flowing to rich countries.