Foreign Capital Inflow with Public Input Production

Foreign Capital Inflow with Public Input Production

This paper develops a general equilibrium trade model of a less developed country, facing imperfect international capital mobility, and producing a public input. Within this framework, the paper examines the welfare effects of an inflow of foreign capital when the government finances the provision of the public input either (i) by taxing the return to foreign capital, or (ii) by imposing a tariff on the imported good. Using the gross domestic product (GDP) function with public input production, the paper shows that (i) in the presence of a tariff, the inflow of foreign capital may increase the country`s welfare, even if the imported good is capital intensive, and (ii) in the presence of capital taxes, the inflow of foreign capital may decrease the country`s welfare. The paper examines also within the two-good, two-factor model the effect of a capital inflow on factors rewards. (JEL: F13, F20)