Working Paper: CEPR ID: DP7010
Authors: Elias Papaioannou
Abstract: This paper uses a large panel of financial flow data from banks to assess how institutions affect international lending. First, employing a time varying composite institutional quality index in a fixed-effects framework, the paper shows that institutional improvements are followed by significant increases in international finance. Second, cross-sectional models also show a strong effect of initial levels of institutional quality on future bank lending. Third, instrumental variable estimates further show that the historically predetermined component of institutional development is also a significant correlate of international bank inflows. The results thus suggest that institutional underdeveloped can explain a significant part of Lucas (1990) paradox of why doesn?t capital flow from rich to poor countries. The analysis also does a first-step towards understanding which exactly institutional features affect international banking.
Keywords: banks; capital flows; institutions; international finance; law and finance; politics
JEL Codes: F21; F34; G21; K00
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| initial levels of institutional quality (O17) | future lending (G21) |
| weak property rights, legal inefficiencies, high expropriation risks (P14) | foreign bank capital (F21) |
| institutional improvements (O17) | international bank lending (F34) |
| 10-point increase in institutional quality index (I24) | international bank inflows (F65) |
| historical determinants of institutional quality (O43) | international bank inflows (F65) |