Sector Specific Inflow of Foreign Capital, Non-Traded Sector and Implications for Real Exchange Rate

Abstract

This paper attempts to investigate the impact on factor prices and real exchange rate owing to an inflow of foreign capital only in the exportable sector of the host country. In doing so, we amalgamate Heckscher-Ohlin and Specific Factor models of trade which is popularly known as the H-O nugget. We show that consequent upon an inflow of capital specific to the exportable sector, both the non-traded good production and the return to the factor specific to the non-traded good decrease while the exportable production expands. The effect of such an inflow of foreign capital on the real exchange rate is unambiguous and it increases.