LABOUR MARKET DISTORTION, TECHNOLOGY TRANSFER AND GAINFUL EFFECTS OF FOREIGN CAPITAL*

Abstract

This paper purports to show that even in a 2 × 2 full-employment production structure, an inflow of foreign capital may be welfare improving in the presence of labour market distortion. However, the existence of labour market distortion is a necessity to obtain this unconventional result. If an inflow of foreign capital is accompanied by labour market reform, the possibility of welfare gain due to foreign capital diminishes. Therefore, there may exist a trade-off between the policies of growth with foreign capital and labour market reform. However, if the inflow of foreign capital is accompanied by a labour-augmenting type technology transfer, it is found that investment liberalization policy and labour market reform may be undertaken concurrently in a developing economy.