Lucas Paradox

In economics, the Lucas paradox or the Lucas puzzle is the observation that capital does not flow from developed countries to developing countries despite the fact that developing countries have lower levels of capital per worker.

Classical economic theory predicts that capital should flow from rich countries to poor countries, due to the effect of diminishing returns of capital. Poor countries have lower levels of capital per worker – which explains, in part, why they are poor. In poor countries, the scarcity of capital relative to labor should mean that the returns related to the infusion of capital are higher than in developed countries. In response, savers in rich countries should look at poor countries as profitable places in which to invest. In reality, things do not seem to work that way. Surprisingly little capital flows from rich countries to poor countries. This puzzle, famously discussed in a paper by Robert Lucas in 1990, is often referred to as the "Lucas Paradox."

The theoretical explanations for the Lucas Paradox can be grouped into two categories.

  1. The first group attributes the limited amount of capital received by poorer nations to differences in fundamentals that affect the production structure of the economy, such as technological differences, missing factors of production, government policies, and the institutional structure.
  2. The second group of explanations focuses on international capital market imperfections, mainly sovereign risk (risk of nationalization) and asymmetric information. Although the expected return on investment might be high in many developing countries, it does not flow there because of the high level of uncertainty associated with those expected returns.

Read more about Lucas ParadoxExamples of The Lucas Paradox: 20th Century Development of Third World Nations, Counterexample of The Lucas Paradox; American Economic Development

Other articles related to "lucas paradox, lucas, paradox":

Counterexample of The Lucas Paradox; American Economic Development
... Although Lucas’ original hypothesis has widely been accepted as descriptive of the modern period in history, the paradox does not emerge as clearly before the 20th century ... has explored in depth this reversal of the Lucas Paradox in the colonial context ... Although not emphasized by Lucas himself, Williamson maintains that unimpeded labor migration is one way that capital flows to the citizens of developing nations ...

Famous quotes containing the words paradox and/or lucas:

    The paradox of education is precisely this—that as one begins to become conscious one begins to examine the society in which he is being educated.
    James Baldwin (1924–1987)

    Lucas: You’re the Democratic nominee for Senator.
    John McKay: You make that sound like a death sentence.
    Jeremy Larner, U.S. screenwriter. Lucas (Peter Boyle)