Has the Lucas Paradox been fully explained?

- The Lucas Paradox is the stylised fact that capital does not flow from rich to poor countries.
- Previous research found that differences in institutional quality fully explain the Lucas Paradox.
- In a replication exercise, we show that this finding is not robust to outliers.
- To do so, we adopt a better functional form and/or remove atypical observations.
- Controlling for institutional quality helps to explain the Lucas Paradox but does not make it disappear.

Alfaro, Kalemli-Ozcan, and Volosovych (2008) argue that accounting for differences in institutional quality makes the Lucas Paradox disappear. We show that their key finding is driven by the presence of outliers. Once we control for them, we find that the Lucas Paradox remains.