Global Governance and Gross Capital Flows Dynamics

One of the famous puzzles in macroeconomics, the Lucas (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 2000 – 2016 period. Using panel regressions incorporating country fixed effects, we argue that institutional quality rather than the effect of diminishing returns of capital is a key explanation for the “Lucas Paradox”. We corroborate 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. Our empirical results highlight the significance of the differences in gross capital inflows/outflows depending on the country’s level of financial development. We show the significance and predominance of financial institutions versus financial markets in the dissemination of gross capital flows.