Increasing Returns, Institutions, and Capital Flows

Does institutional quality resolve the Lucas Paradox?

“…Doornik and Hansen's (2008) The results for these tests in Table 1 for AKV's linear-log functional form (in columns (1), (2), (7) and (8)) provide strong evidence of misspecification, with p-values for all the tests equal to zero to at least two decimal places. Snyder (2013), examining similar IFS data on capital flows per capita, argues that a linearlinear model provides a better fit than a linear-log model, "which may be a contributing factor for why AKV found the coefficient on log GDP insignificant when controlling for institutional quality" (p.288). A linear-linear functional form, as in Table 1 (Burbidge, Magee, and Robb 1988;Busse and Hefeker 2007).…”

“…richer countries attracting larger capital flows) disappears if an institutional quality index is included as an explanatory variable in the regression model. This resolution of the Paradox has been questioned in studies reporting results for crosssectional regression models in which the addition of institutional quality as a regressor does not fully account for the significant effect of income per capita (Azémar and Desbordes 2013;Snyder 2013;Göktan 2015). The source of much of the conflict between AKV's results and those of their critics centres on the appropriate model specification that is used as a basis for assessment of the statistical significance of the coefficients on income per capita and institutional quality.…”

The Interaction Effects of Globalization and Institutions on International Capital Flows

“…Several prior studies have proposed that institutional quality indexes could be too broad to capture the effect of institutions on the Lucas Paradox. Both Okada (2013) and Snyder (2012) investigate the effects of sub-components of institutional quality on capital flows. We investigate four sub-components of the broad measure of institutional quality: sanctity of legal property, quality of monetary institutions, degree to which tariffs are used, and regulation of established policies.…”

“…This negative coefficient on GDP suggests that when institutional quality is taken into consideration, the Lucas Paradox no longer exists (Alfaro, Kalemli, & Volosovych, 2008). Snyder (2012) qualified this finding by showing that different measures of institutional quality have different impacts on capital flows; moreover, the effect of institutional quality on capital flows is different in poor countries than in rich countries. Snyder's finding implies that institutional quality's impact on capital flows varies with the level of economic development.…”

“…Our paper focuses on the summary index that includes all five sub-categories. We do include one set of regressions using individual sub-indices to address the precedent set in Snyder (2012) that says different forms of institutional quality might have different relationships with capital flows.…”