Lecture 10
Foreign Direct Investment (FDI)

1. Why does capital move?

• To earn a higher return
• In LDCs, low capital stock
  • High marginal productivity of capital

2. Factors affecting capital mobility

• Wage differentials
  
  • Low MPL in LDCs (why?)

• Infrastructure
  
  • Telecommunications, roads, airports

• Taxes and regulations
  
  • Tax holidays
  • Repatriation of profits

• Political stability
  
  • Fear of changes in laws
  • Threat of nationalization

• Tariff-induced investment
  
  • Actual and expected protectionism

• Exchange rates
  
  • Depreciation of foreign currency makes foreign labor cheaper
  • More relevant for DCs

• Macroeconomic environment
  
  • Current and future GDP
  • Inflation

3. Gains from capital mobility

• Two countries, A and B
• Initial endowments of capital stock: K_A > K_B
• Sketch MRP_K schedule for each country
• Note: R_A < R_B (Closed-economy case)

• Direction of capital flow?
• Interest rate in Country A rises; that in B falls
• World eqbm interest rate

Less K leads to lower output (income) which is ...
... more than offset by investment income from abroad