Foreign capital inflow and its welfare implications in a developing country context

Rudrarup Mukherjee

doi:10.5018/economics-ejournal.ja.2017-17

Abstract

Abstract In a small open developing country context, the author considers a three-sector general equilibrium framework and tries to find out the effects of foreign capital inflow on welfare of the country. Comparative-static results show that foreign capital inflow widens the skilledunskilled wage gap under some reasonable conditions, although it causes an expansion of the foreign enclave and the agricultural sector and contraction of the domestic manufacturing sector. Taking sector specific foreign capital, the authors find that foreign direct investment is beneficial in a free market small open economy in the absence of tariff.

Highlights

The impact of foreign-capital inflow on the welfare of a developing economy has always been a subject of immense interest among the policymakers and the academicians
Two-factor framework, characterized by the presence of full employment, they have shown that, if the relatively capital-intensive sector is protected by tariff and, the income from foreign capital is fully repatriated, an increase in foreign-capital inflow would cause a loss in welfare of a country
The main objective of the present exercise is to develop a model to find out the impact of foreign-capital inflow on welfare of a small open economy, with agriculture, domestic manufacture and foreign enclave being the three sectors of the economy

Summary

Introduction

The impact of foreign-capital inflow on the welfare of a developing economy has always been a subject of immense interest among the policymakers and the academicians. The inflow of foreign capital cannot influence the welfare of a country if the import-competing sector is not protected This is the famous Brecher-Alejandro’s (1977) proposition of the trade theory. Beladi and Marjit (1992a) have re-examined the Brecher-Alejandro’s (1977) proposition in a fullemployment model proposed by Heckscher-Ohlin-Samuelson, in the presence of an export-processingzone (EPZ) that uses the sector-specific foreign capital. This work invents the conditions under which one can find out the negative effect of foreign-capital inflow on welfare of a country It happens when the foreign capital is not injected directly into the import-competing sector, but it changes the composition of output in other traded sectors through the inter-sectoral reallocation of the existing resources.

The Model

Inflow of Foreign Capital

Foreign-Capital Inflow and Skilled-Unskilled Wage Gap

Foreign-Capital Inflow and Expansion of Three Sectors

Foreign-Capital Inflow and Welfare in Absence of Tariff

Concluding Remarks