The sample of countries for this study includes 40 countries, 8 have high economies and 32 other countries. The eight top economies include Brazil, Canada, China, France, Germany, Italy, Japan, and South Korea. To narrow down the comparison, this study selected the current accounts from Turkey as a representative of developing countries and the United States as a representative of developed countries. The table below shows the fluctuation of current account to GDP in Turkey from January 2004 to January 2012.
Source: Trading economics http://www.tradingeconomics.com/turkey/current-account-to-gdp
Source: http://www.tradingeconomics.com/united-states/current-account-to-gdp
The current account to GDP in the U.S.A shows a countries international competitiveness. Countries with strong current account surplus are characterized by economies that are highly dependent on export income, have low domestic dependence and have high savings. In contrast, countries with high current account deficits are characterized by high level of imports, high personal consumption and low savings. The comparison of the current account to GDP charts shown between Turkey and the U.S.A show a clear distinction in the levels, but bear the same trend apart from the year 2011/12. This is an indication that both of them have almost the same level of international competitiveness, but the U.S has an edge and is a better performer, especially in the most recent years.
Source: Trading economics http://www.tradingeconomics.com/turkey/current-account
Source: http://www.tradingeconomics.com/united-states/current-account
The fluctuation differences between Turkey and the U.S show that there is a high growth in the U.S compared to Turkey. This asserts the theory that the developed country’s current account grows steadily and by a higher margin than developing countries. The fluctuation in the U.S Current account is not as frequent and in small levels as that of Turkey.
Capital flows in Turkey in 2011 stood at 35398000000. This consists of portfolio investment and net FDI. The trend shows fluctuations over the ten year period. There was an increase from 202 to 2006 followed by a decline back to a low level that is slightly higher than what was in 2003. However, 2010 and 2011 experienced robust capital flows that were higher than received before.
Empirical model
Qit= Ait Kitα Zitβ HitY
Assuming constant returns to scale, α+β+Y = 11
Qit = Ait (kit /hit)α (zit/ hit)β hit
Lucas discusses the capital flow between rich and poor countries, assuming that they operate in one sector economy. Assuming the Cobb-Douglas production function in an open economy with capital K, and labor L as components of output, Agents borrow or lend internationally.
Yt = AtF(Kt;Lt) = AtKtα Lt1-α
FK(:) > 0; FL(:) > 0; FKK(:) < 0; FLL(:) < 0;
Assuming that the 40 countries share common technology, the mobility of capital will imply the convergence of returns to capital. In this case, for countries i1 to i40
Atf(ki1t) = rt = Atfit);
Where FK(:) represents the net deoreciation of production in terms of per capita whereas k represents capital per capita. The hypothesis is that resources wll flow from countries with capital abundance (low returns) to those with scarce capital (high returns) causing a diminishing returns to capital as the transit process transpires. According to Lucas, human capital and land affect returns to capital positively but arent considered by the neoclassical approach, and could be the factors which explain the lack of flow in capital from rich to poor countries. This would mean that the actual production function is:
Yt = AtF(Kt;Zt;Lt) = AtKt αZtβ L t1-α-β;
Zt represents other factors in the production process. Therefore, the returns from country 1 to country 40 will be given by;
Atf(ki1t; zi1t) Atf(ki40t; z i40t) = rt = Atf(Ki1t;Zi1t) Atf(ki40t; zi40t):
The emerging differences in the government systems and policies among the 40 countries also posed as potential factors to the lack of capital flows from the rich to poor countries. Therefore, the theoretical framework has to consider this factor. The government policies may include taxation policies, capital controls among other distortive government influences/ policies. The distortive effects of the government policies may make slight alterations to the empirical model by introducing the varying government capital return rate among these countries.
= Atf(ki1t)(1-ɤi1t) = rt Atf(ki2t)(1-ɤi2t)i40
This model also needs to consider the formal and informal regulations that affect the hypothesis. This includes traditions and customs, laws and constituions.This affect institutional structures in the form of social economic and political institutions. The parameter At takes into account the variation of overall efficiency of the 40 countries. It is apparent that the level of technology in these countries differs because of adoption barriers or issues with the technology level. The return of technology will have this model
Ai1tf(ki1t) = rt = Ai2tf(ki2t)i40:
Data
Using cross country OLS regression, to consider the changing explanatory variables as time goes by, a comparison may be drawn. A linear regression may be created with average inflows per capita F, for each country. This will include a constant µ, the log of GDP per capita Yi, and average institutional quality Ii.
Fi = µ + α log Yi +βIi + εi;
εi is a random statistical error. β and α are coefficitients of interest. Β is the coefficient of interest of the portfolio equity investment per capita whereas α is the coefficient of interest for direct equity. The 40 countries samples for the whole world. The sample of 40 countries is comprised of poor and rich countries and large open and small open economies. The per capita element takes into account the size effects.
KLSV Capital Flows Data: Base Sample of 40 Countries
,
Conclusion
This study finds an explanation for the Lucas Paradox. The results show that the variable institutional quality ensures that the Lucas paradox goes away. This paper’s object analyzes the explanation behind the lack of capital flows into poor countries from poor countries, both theoretically and empirically. According to the empirical studies, the institutional quality is the main causal variable for this explanation. Theoretically, policies from different governments increase the capital inflows into developing countries. Institutions play a major role to achieve high levels of revenue. This could be transparent where these institutions facilitate foreign investment in the long run development.
Appendix
Capital Flows of the 40 sampled countries
