Question

In Lucas' Paradox: "Why Doesn't Capital flow from Rich to Poor Countries?", please answer the following questions.

While comparing the production per person in U.S.A. and in India, what kind of assumptions Lucas makes in his model? What does he say about the parts that do not fit to the real data about these assumptions? ’Why doesn’t Capital flow from USA to India?

Answer 1

The Lucas paradox states that capital does not flow from developed countries to developing countries despite the fact that developing countries have lower levels of capital per worker In the situation of USA vs India , USA is much rich nation than India but there is 5800% difference between the two nations MPK or marginal product of capital .The assumptions that Lucas paradox states ,firstly that the limited amount of capital transfer between the two countries the amount of capital recieved by poor nations is very less then the factors thet affect the production like technological differences, missing factors of production, government policies etc . Second assumption is that it focusses on market factors like  mainly sovereign risk (risk of nationalization) and asymmetric information , it states that the expected rate of return must be high but there is high uncertanity in market. The capital doesn't flow from USA to India because of the reason that Indian subcontinent has mainly semi skilled or unskiled labours and there is high risk of market uncertainity in India .Also the reason that arises is that amount of oppurtunity cost wil be more foor the US as there are many segments that Indian economy has to rectify for the growth and capital mobilization.