Foreign Borrowing, and Optimal Intervention to Achieve Non-Economic Objectives

Abstract

In a seminal paper, Bhagwati and Srinivasan [3], using a standard two-sector model, elegantly presented the optimal policies that a country should follow in the presence of some non-economic objectives. Their analysis was subsequently extended by Tan [8] who incorporated imported raw materials, inter-industry flows and nontraded goods, and by Yu [10] who introduced a pure intermediate product in the standard model. The objective of this paper is to extend the Bhagwati-Srinivasan analysis in another important direction-that is, allowing for borrowing of foreign capital. The practical significance of foreign borrowing can hardly be overemphasized in view of the developing countries' need for foreign capital; even for some developed economies such as Canada and Australia, foreign investment does play a decisive role. Bhagwati and Srinivasan [3] considered four noneconomic objectives: (a) the output of a particular good should not fall below a specified level; (b) the value of imports should not exceed a specified level; (c) factor employment in a particular sector should not fall below a minimum level; and (d) domestic availability of certain goods (luxuries) should not exceed an upper limit. In addition to these, we will consider one more which comes naturally in the presence of foreign borrowing-that is, (e) an upper limit on the level of foreign investment. This is particularly relevant for developing countries where self-sufficiency with respect to foreign investment is one of the major, ambitious goals of long-term planning [1, 119]. In the next section, the optimal policies are deduced assuming that the country is competitive in trade as well as in borrowing capital. In Section III, monopoly in trade and imperfection in international capital market are analyzed in turn.