Global governance and gross capital flows dynamics

Abstract

One of the famous puzzles in macroeconomics, the Lucas (Am Econ Rev 80:92–96, 1990) paradox on “why doesn’t capital flow from rich to poor countries”, continues to exist and shapes capital flows in the modern world. This paper provides cross-country evidence on the role of politico-institutional and financial determinants in gross capital flows dynamics over the period 2000–2016. Using panel regressions incorporating country fixed effects, the study argues that institutional quality rather than the effect of diminishing returns of capital is a key explanation for the “Lucas Paradox”. It corroborates previous empirical evidence that government effectiveness, regulatory quality, rule of law, and political stability remain the most important institutional indicators in determining gross capital flows dynamics, highlighting the symmetric effect. In contrast, voice and accountability, and corruption are not significant determinants of gross capital outflows dynamics. The main contribution of the paper comes in identifying the link between the multidimensional nature of financial development and gross capital flows. The empirical results highlight the significance of the differences in gross capital inflows/outflows depending on the country’s level of financial development. The study shows the significance and predominance of financial institutions versus financial markets in the dissemination of gross capital flows.

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Notes

  1. 1.

    We extend the analysis in Cowan et al. (2007), Broner et al. (2013), Álvarez (2015), and Alberola et al. (2016).

  2. 2.

    The description and methodology of the construction of financial development indices are provided in the articles of Cihák et al. (2012), Sahay et al. (2015) and Svirydzenka (2016).

  3. 3.

    Johnson et al. (2000) argue that tunnelling represents the transfer of funding and assets out of companies to meet the interests of their controlling shareholders. This means that capital will flow out of countries regardless of the level of financial development because private capital flows are harder to regulate.

  4. 4.

    See Introductory Econometrics: A Modern Approach by Wooldridge (2012) for discussion and derivation.

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Acknowledgements

We would like to thank conference participants for their comments at the Alliance Manchester Business School Conference, May 2018. We also appreciate comments at the 5th Young Finance Scholars Conference 2018 at the University of Sussex, 8 June 2018, and BAFA Corporate Finance and Asset Pricing Symposium, 5-6 July 2018, MediaCityUK, Manchester, UK.

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Appendix: Descriptive statistics and benchmark regression results

Appendix: Descriptive statistics and benchmark regression results

See Tables 8 and 9.

Table 8 Descriptive statistics
Table 9 List of countries

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Osina, N. Global governance and gross capital flows dynamics. Rev World Econ (2021). https://doi.org/10.1007/s10290-020-00404-z

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Keywords

  • Lucas Paradox
  • Global governance
  • Financial development
  • Gross capital flows dynamics
  • Feldstein-Horioka puzzle

JEL Classification

  • F30
  • F34
  • F62
  • F63