Public infrastructure, employment and sustainable growth in a small open economy with and without foreign direct investment

Abstract

The paper builds a theoretical model of endogenous growth motivated by the recent Indian paradox of an improving GDP growth rate in the face of unsatisfactory employment growth rate. The source of the problem is believed to be inadequate growth of manufacture for the absorption of unskilled or semi-skilled labour in rural sectors. The paper studies the impact of free trade on employment and GDP growth in a small, developing economy in the absence as well as presence of foreign direct investment. The model also recognizes the importance of public infrastructure accumulation to support the growth process. The results indicate that free trade with or without a corresponding free inflow of foreign capital into the manufacturing sector has a positive impact on employment and GDP growth. However, the beneficial effect is stronger in the presence of foreign capital. Foreign and domestic capital grow at equal rates in equilibrium.