A conceptual framework for analyzing the effects of foreign private capital flow in development economies

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ECA/MRAG/95/2/TP

Addis Ababa April, 1995

" I

ECA/MRAG/95/2/TP

UNITED NATIONS ECONOMIC COMMISSION FOR AFRICA MULTI-DISCIPLINARY REGIONAL ADVISORY GROUP

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Addis Ababa April 1995

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ECA/MRAG/95/2/TP

TABLE OF CONTENTS.

I. INTRODUCTION . . 1

II. UNDERLYING ASSUMPTIONS OF

THE CONCEPl'UAL FRAMEWORK • . • • • • • • • • • • • • 4

III. THE EFFECTS OF PRIVATE FOREIGN CAPITAL FLOWS • • • • 7

1. Tax Revenues from Business Profits 8

2. Employment and Income Effects . . . • . 9

3.

4.

Domestic savings and Investments Domestic Consumption

12 13

5. Domestic Economic Growth Rate . . . • • . 14

6.

7.

8.

IV.

Terms of Trade Effects Balance of Payment Effects External Economies

CONCLUSION

17 18

18

20

I

V • F O O T N O T E S . . . 22

j 1-·1

., I

ECAfMRAG/95/2/TP

A CONCEPTUAL FRAMEWORK FOR ANALYZING THE EFFECTS OF FOREIGN PRIVATE CAPITAL FLOWS IN DEVELOPING ECONOMIES

By

Wilfred A. Ndongko

I. INTRODUCTION

Before 1914, the theory of international trade was dominated by the Ricardian assumption that factors of production were not mobile between nations. By the time Ohlin had revised the existing theory to incorporate the international movements of labour and capital, "the classical assumption of international immobility of productive factors had almost become perfectly valid in fact".

¹

As it is in the case with most theories, every textbook on international trade has dwelled on the conception that capital moves internationally "from countries where it is plentiful and cheap to those where it is scarce and expensive.

^'12

Al though, it is occasionally pointed that "abnormal capital movements" do take place, they are not held to invalidate the traditional view that

"normal" capital moves from capital rich (low interest) to capital poor (high interest) countries.

It should, however, be pointed out that the received doctrine

is not consistent with the facts of the real world, especially when

it is considered that since 1914, capital has failed to move from

capital rich to capital poor nations. Furthermore, interest rates

are not always higher in capital poor than in capital rich

countries,' and indeed capital does not always move from low-

interest to high-interest areas. Rather, the fundamental

explanation of the growth of direct private investment in many

ECA/MRAG/!l5/2/TP Page 2

developinq economies lies in the existence of profit opportunities that the investment can afford, and much more important on the existing, legal and institutional guarantees and incentives for private foreign investment. To this extent, the purpose of this paper is to propose a conceptual framework for analysing the impact of foreign private direct capital flows and investment on the economies of developing countries. The basic assumption is that the total planned investment in any developing economy for any given period of time generally for exceeds the available domestic savings and therefore the state relies on the flows of direct foreign private capital to fill the gap

It is basic to the understanding of the developmental role of private foreign capital that i t can and will offset or "finance"

some or all three of the following differences as aggregates: (a) value of products used minus value of products produced domestically; (b) net investment minus domestic savings; (c) value of Lmpor-t.ed goods and services including factor payments minus value of exported goods and services, including factors receipts.' Chenery has, in fact postulated a theory known as the "gap theory", which appears in the forms (a), (b) and (c). He has, in addition, provided a formal and empirical foundation to this theory in his study of Israel with M. Bruno.'

Considering the operational relevance of the framework being proposed in this paper, attention will be focused on that aspect of the gap theory which deals with the insufficiency of domestic savings in developing countries. The other aspect of the gap theory which relate to the inadequacy of export earnings to pay for the necessary capital imports, is only a production function constraint:. This is because by eliminating this bottleneck, an important surplus can increase the efficiency of investment. This will result to a shift of the entire production function with a consequent increase in the rate of growth through the use of the

---_.

, , I

ECA/MRAG/95/2/TP Page 3 available domestic savings and the additional private capital flows from abroad. In other words, the expansion of trade in general is such that exports do not grow as fast as the demand for more imports, import surplus will increase the absorptive capacity of the econolny and, thereby increase the attainable rate of economic growth. At a later stage, exports will gradually catch up with imports and the developing economy will be able to achieve a trade balance while preserving the high rate of growth.

Perhaps a restatement of the "savings gap" theory will through

more Li.qht; on the nature of the problem. To this end, the usual

point of departure is the Harrod growth equation : g

=

sk, where

"g" is thE! proportional rate of growth of national income, "s" is the proportion of national income saved and invested in the developing economy Cameroon, and "k" is the incremental capita- output ra1:io. Thus "s" and "k" can be written as :

(1) s = sY = I

(2) K

= .x,

Y

where

"K"

is the available domestic capital and

"Y"

is the national income. ThUS, when there is an inflow of private foreign capital 'a' into a developing economy, (Which is a fraction of its national income) the growth rate will rise to:

( 3 ) g = (s+a)K

If the g* is the target or planned rate of growth and if "k"

is assumed constant, one can deduce the rate of capital accumulation "c" which is necessary to achieve the target given. It can be written as :

(4) c

=

g*/k.

ECA/MRAG/'I}S/2/TP Page 4

The difference between "c" and "s" indicate the savings gap.

The amount of capital flows necessary to achieve the target can therefore, be written as

(5) a = c-s

Having demonstrated that the "savings gap", does in fact exist, the paper will now attempt to present a conceptual framework for analyzing the flows of private foreign capital flows in developing economies.

II. UNDEULYING ASSUMPTIONS OF THE CONCEPTUAL FRAMEWORK

Aparc from the pioneering paper of Sir MacDougall on the nature of effects of private capital flows on the Australian economy, and which had earlier been factually analyzed by Ardnt, 7

there does not appear to be in the literature on the private foreign capital flows into developing economies, any coherent and systematic theoretical framework within which the performance and impact of such flows can be analyzed. In this regard, i t should be noted that many developing countries while making all necessary efforts to encourage the inflow of private capital into their economies are also very concerned about the benefits and costs of such flows. To this extent, therefore, the analysis that will be undertaken in this paper will consider both static and dynamic aspects of private foreign capital flows.

Bearing the foregoing fundamental assumptions of the

remarks in mind, the conceptual framework are

underlying as follows:

(i) there has been a steady increase or decrease in the flow of foreign private capital investment into a developing economy X since year t l

__ l'" I

."ECA/fffiAG/95/2/TP Page 5

(ii) the developing economy is. not fully .employed (a large poll of unemployed labour exists in the rural areas of the economy)

(iii) taxation of business profits and income is made by the government;

(iv) the size of the labour force does depend partially on the stock of capital from abroad;

(v) the size savings, capital,

of the developing economy X own capital and although initially independent of foreign will indeed be influenced by it in the long run;

(vi) there are external economies resul"ting from foreign capital flows into economy X;

(vii )

(viii)

there are increasing, constant and decreasing returns to scale;

an increase or decrease of private capital flows from abroad may affect the terms of trade;

( i x ) . f o r e i g n capital flows can create balance of payments difficulties which mayor may not be adjusted smoothly;

(x) domestic current consumption is affected by the inflow of foreign capital stock, and

(xi) any additional increase of capital f Lowa into economy may require either a revision of the provisions of the existing investment legislation or changes in government po li cy which mayor may not involve a loss, at least temporary, to the economy_

ECA/MRAG/~15//TP Page 6

Figure 1 •

J

a

II I

D

Gi ven the foregoing assumptions, the size of capital flows from abroad into economy in rll!lation to the domestic capital stock is shown in Figure 1.

E

\-1PIk

' - - - , - ' - - - - -....----...l.---,~apitalstock

A B

c

G

If i t is assumed, that there are only two factors of production - labour (L) and capital (K), then the line EH in Figure 1. relates the physical capital stock in economy X to the marginal physical product of capital (MPPK), given the amount of labour (L).

In year t l the total capital stock in economy X was AI: of which AB was owned by nationals of economy and BC by foreigners. That is, AC

= AB + BC.

Following the earlier assumptions, since profits per unit of

.~

capi tal (11K), are equal to MPP., total earnings are DOAB on economy X capital and OFBC on foreign capital. Therefore, the total

~11K earned on a 1 cap1tal sock 1S :. 1 . t . IlK -. nOABV + OFBC

ECA/MRAG/95/2/TP Page 7 since the total output is EACF, labour earnings are presented by DEF.^s On the basis of this framework, the paper will now attempt to analyzE! the effects and performance of an additional increase in direct private foreign capital stock from BC to BG. It is assumed here, that: the increase of CG originates mainly from abroad and not from the growth of the already existing capital stock (BC).

III. THE EFFECTS OF PRIVATE FOREIGN CAPITAL FLOWS

Generally, an increase in capital flows into economy of CG, will result to a rise in total output of FCGH. New foreign profits are now NBGH, where additional new increase (CG), of foreign capital earns JCGH, and the old foreign capital (BC) loses OFNJ because the MPPk, and hence the profit rate (11K), have decreased.

However, i.t would appear that total foreign profits on the balance will rise, due to the fact that the "elasticity of: demand for foreign capi tal" • (assuming that the costs of imported capital are not too high), is probably greater than unity.

with regard to indigenous investors of economy X, the loss is DINO, whilst labour gains DIHF (assuming that no other labour is imported along with the additional foreign capital inflow of CG).

Thus, the total gain by economy X is ONHF. In view of the fact that FJH is relatively small, the net domestic gain is ONFJ, which is the loss of income by the old foreign investors (BC).

It would appear that indigenous labour may not gain all of DIHF, (that is the total increase in real wages owing to a rise in the marginal physical product of labour (MPP1 ), but only a fraction ~Ihich is equal to the ratio of all foreign capital stock (BG) to total capital stock (AG). This may be due to the fact that a large proportion of the labour gain is nothing else but a redistribution from the indigenous investors of economy X.

ECA/MRAG/95/2/TP Page 8

Before the performance and effects of additional foreign capital flow into economy are analyzed, i t should be noted that there is an extensive, though not systematic and rigorous theoretical contributions to the nature of the effects arising from capital flows into developing economies.'o Apart from this, a series of case studies of the performance of such direct capital flows to developinq countries have also been undertaken. ^U Bearing this in mind, the paper will now attempt to analyse briefly the nature of the benefits and/or costs that may have resulted from the inflow of direct foreign capital to developing economy X.

1. Tax Revenues from Business Profits.

Given assumption (iii) regarding taxation of business profits and Lncomes by the Government of economy, suppose that the tax rate on foreign earnings is "t". This will usually approach one-half in the case lo1here all the profits are distributed. Thus, in terms of Figure 1. ,. economy X will gain, in addition to ONIF, the tax on the net increase in foreign profits. In other words, the gain which is the form of tax revenues is t (JHCG) plus I-t (ONJF) instead of ONJF. Thus, the total tax revenues accruing to t:he government from earnings of foreign private investment is T. = t(JHCG) + 1-t(ONJF), where Tf is the tax revenue from foreign investors in economy X.

It should be pointed out that taxation is not indicated on Figure 1., so as not to complicate the analysis. The opposite situation" where the additional inflow of foreign capital stock is induced by making a reduction in the tax rate on foreign profits and incomes, can be regarded as a change in government policy. This is in compliance with the assumption (xi) made above. In such a case, where the tax rate on foreign profits is reduced to encourage an additional inflow of capital from abroad, there may be a reduction in total tax revenues from foreign profits.

i'

" I

ECAfMRAG/95/2/TP Page 9 This can, however, be avoided only if

(1). _1_ + _1_

1 + 1

"s

< t;

where "t" is the original tax rate, and "d and "s are the positive elastici ties of demand for and supply of forei.gn capital. These elasticities measure the relationship between changes in the stock of foreign capital in economy X and the profit rate before tax in the case of demand and after tax in the case of supply.^1>

However, if "t" is assumed to be one-half, then the result becomes:

( 2 ) . "s

_ _1 __

:2: 1 - _2_

, , I

"d

Since "d is high, a decrease in tax revenue may be avoided if the

"s is of the magnitUde : 1 < "s < 2. This may not be true since foreign capital in economy X is only a small proportion of the foreign capital in other developing economies. Whether this, in fact, is not true, can only be determined after relevant empirical evidence has been brought to bear on the hypothesis.

2. Employment and Income Effects

Considering assumption (iv), regarding the partial dependence of the labour force of economy X on the volume of foreign direct investmen1:, an increase in the flow of capital stock. from abroad will certainly induce an influx of unemployed labour from the rural sector to the Urban areas. This is consistent with assumption (ii), particularly if i t is borne in mind that the shortage of capital does impede the employment of labour from the rural sector to the modern industrial sector where wages are higher.

ECAfMRAG/95/2/TP Page 10

This effect can be analyzed in terms of Figure 2 which is the same as Figure 1., except that line EQ indicates an increase in foreign capital given by the distance FQ.

Figure 2.

MPPk E

:::::--..

<,

<,

< ,

0 F ... Q

- -

^~l

- - -

A B C G

~---_·....L.._-_...L-

_ _

. L - _ - - - " l C a p i t a l stock (K)

Let CG be 1% of AC, and suppose that the labour force is increased by 1%. 'rhis will result to a shift in the line relating the marginal product of capital (MPPk) to the capital stock (K) from EH to EQ. As a consequence, total wages are increased from DEF to DEQ. This increase in the wage bill is equal to 1%.

Apar1: from the increase in the level of employment, the nature of the effect of capital flows on the national income of economy can be shown with the use of Figure 3.

ECAfMRAG/95/2/TP Page 11 Figure 3.

MPP~

R

L---...

·---'f---'~bour (L)

o ^P u

It can be observed from figure 3, that the line SV indicates the MPPL (mar9inal physical product of labour) corresponding to the different quanti ties of labour (assuming that the total capital stock in economy X is fixed at the level reached after the addi tional increase of private capital investment from abroad). If the labour supply is increased from OP to OU, then the elasticity of demand for labour with respect to its MPPL (that is, the line SV at Q), can be written as :

ndL

=

WVUP

= -

MPPL. L RQWT L.4MPPL

L and ~[PPL are changes in the quantity of labour (L), and its marginal physical product (MPPL ), respectively.

From Figure 3., it. can also be observed that the total change in the national income of economy is given by :

WVUP - (l-t) XQWY, or

WVUP - c(l-t) RQWT,

ECA/MRAG/95/2/TP Page 12

where WVUP is the increase in output; I-t (XQWY), is the increase in the profits of foreign investors, with "t" and "c" being the tax rate on the profits and the ratio of foreign capital stock to total capital stock, respectively: consequently, the condition for an increase in the national income is given by:

"dL

= WVUP

RQWT

>

c(l-t)

This is because the range of sUbstitution between capital and labour is probably large, and perhaps greater than c(l-t).

3. Domestic Savings and Investment

It is generally argued that the domestic savings and investment of an economy encouraging the inflow of capital from abroad, will at some future date increase. Foreign capital flows may have the effect of stimulating domestic capital formation through the demand side. It can also do so from the savings side.

To achieve this objective, however, domestic measures may have to be introduced to channel a larger proportion of foreign profits into the domestic indigenous productive economic sectors.

The above increase in domestic savings may however not

necessarily take place, particularly as there may be redistribution

of income away from domestic capital when foreign investment

competes with rather than complements domestic investment, and

thereby reducing profits on indigenous investment in the developing

economy. This, therefore, is an indirect cost of imported capital

from abroad.

ECA/MRAG/95/2/TP Page 13 4. Domestic consunpt.Lon

It will be recalled that the saving-gap model was based on the assumption t.hat; any additional private capital flows from abroad is channelled to raising the rate of capital accumulation, which will narrow thE~ savings-investment gap. However. foreign capital flows into developing economies may reduce domestic saving by stimulating t.he consumption of importables and exportables created by the presence of such capital from abroad. In particular i t would appear from the nature of some of the production, activities carried by foreign investors in many developing economies, that consumption is being supplemented. To this extent, the choice of the government between present and future consumption ((t and (t + 1 respectively), can be presented in terms of the indifference curves and bUdget lines as shown in Figure 4.

Figure 4.

F (et+~

~~

u r

e

C

b.{

o

n

S

u

m

p t i o n

---..:~--Io

o 61.

Current

'- ConsUlIIption

It· can be observed from Figure 4 that the slopes of the indifference curves ( 1₀ and I i ) reflect the government's time preference!, and the slope and position of the bUdget line are determined by the amount of domestic capital stock available to be

ECA/MRAG/95/2/TP Page 14

allocated and the rate of return on investment (which, in this case, is assumed to be equal to the interest rate). 'l~he initial point is ^IIE" .

An increase in the flow of foreign capital into economy X by an amount EG, will shift the budget line or production frontier from b, b, to b, b, , and under no circumstances will either present or future consumption decline, since neither of these bundles has been considered "inferior" by the government. The implication of this analysis is that the additional increase of capital flows from abroad has been channelled into the production of both capital and consumption goods. Therefore, rather, as assumed by the savings-gap model t.hat; the new equilibrium position will be directly above E i.e. E¹ so that C. remains constant, i t will instead be only at H, where both

c.

and C. + 1 are higher than E.

The conclusion is therefore, that the inflow of foreign capi tal s1:ock of EG has led to a rise in current consumption by the distance :E:F which is equivalent to a fall in domestic savings as demonstra1ted earlier.

5. Domel,tic Economic Growth Rate.

The savings-investment gap theory examined earlier argues that additional foreign capital investment in economy will raise the country's growth rate by "ak". In view of the arguments of sections 3 and 4, that most foreign direct capital flows supplement consumption, and that only a small part is directed to productive activities, i t is possible that capital from abroad, can increase the rate of growth by much less than the savings gap theory propounds; namely by (l-m) ak; where m is the proportion of foreign capital allocated to consumption activities.

I

ECAfMRAG/95/2/TP Page 15 The possibility of such a situation taking place depends on whether or not private foreign capital inflows (K' ) lowers domestic savings (8) and the incremental output - capital ratio (K). An a1:tempt to demonstrate how this affects the rate of growth (g*) is made by the use of Figure 5.

fS..

_{Figure 5.}

D

0 m e

s

S--...

t

i

-~

c

,I

s I,

~

a v

i

--J -1.-

n S

g

l I

s

Q

xr, xr,

Kf2 B

~

^G

C

^K•

Volume of Private capital Inflows

It can be observed from figure 5 that the investment frontiers EB and EC indicate the various combinations of domestic and foreign capital stock that can be used to achieve a given target rate of growth g* .. The intercept on the vertical axis is determined by g*, and by the "k" that would prevail if all the planned investment for a specified period of time was financed with only domestic savings.

The value of the intercept is Yo (g*/k), where Yo is the initial gross donast.Lo product (GDP).

The slope of the frontier depends on the extent to which foreign capital inflows affects the output-capital ratio. It foreign capital leaves "K" unaffected, then the slope of the

ECAfMRAG/95/2/TP Page 16

frontier ·...i l l be minus 1, that is EB; but if "k" declines, the slope will be less steep, that is EC. The line SSo is the domestic savings function, which is inversely related to foreign capital flows.

Thus., if the initial domestic savings are so, and the inflow of initial private foreign capital is Kfo, an additional capital imports of Kfo Kfi will be necessary to achieve the target growth rate g*. But if there is an adverse impact of direct capital flows on "k", t.hen a much larger volume of such flows that would be required is equal to Kfo Kf2. In fact, an amount of Kfo Kf3 would be required to offset the decline in "k" and the fall in savings from So to 51. To this extent, economy X will probably be swallowed by privat;e foreign capital.

The extent to which this can happen in economy X will become clear when the suggested framework is tested. Infact, i t would be interesting to see whether the argument that most foreign private inflows 1:0 developing economies go into the production of consumption goods with the consequent reduction of "k", does not call for a discouragement of such capital flows by an amount equal to Kf4 Kfo in Figure 6.

ECA/MRAGj95j2jTP Page 17 Figure 6.

E

L---'----~,___---,--''''---_jt{f

D

o

:11

e s 5_{0 1} t i c 5 5'1

; I

J.

n 9(s)

o

C

Private Foreign Capital Flows

Such a policy, could be based on the assumption that the reduction of foreign capital flows could lead to an increase in the domestic savings and a rise in the incremental capita-output ratio (k). As a result, therefore, the rate of economic development in economy X will increase. The price that will be paid is a reduction of current consumption. Whether or not this is plausible in the case of economy X will depend on the magnitude of the benefits and costs involved and the trade-off between them.

6. Terms of Trade Effects.

The usual consequences of foreign capital flows on the terms of trade are related to the transfer problem - the terms of trade tend to improve with an inflow of capital, and then worsen when there is"asubseque:nt outflow of capital. In the case of economy X,

atte~tion could be focused on the reasons for the observed trend in its terms of , trade during a particular period of time. It could be determined, whether the changes in the terms of t.rade have been due

ECA/MRAG/95/2/TP Page 18

to the transfer of profits abroad; increases in domestic income and output resulting from extra foreign capital inflows or to the structural changes associated with the pattern of development that has resulted from capital inflows.

7. Balance of Payment Effects

The general theory of the balance of payment effects resulting from foreign capital inflows and the liabilities created, do not require elaborate comment. Although the additional inflow of foreign capital may ease the development of economy X, it may also give rise to problems of balance of payment adjustment. However, the magnitude of this problem will depend on whether the foreign capital flows to economy X is "import-saving", or "export- creating". If it fulfils these criteria, then the adjustment problem can be handled easily. On the other hand, if the extra foreign capital inflow is "import-creating", or " export- discouraging", then the adjustment problem will be aggravated, and

losses will be incurred in economy X.

8. External Economies

In accordance with assumption (vi), there is a possibility for external economies resulting from additional foreign capital inflows to economy X. These are economies external to the foreign firms investing the additional capital flows. If the value added to output by this capital exceeds the profits before tax earned on it, the difference will be the value of such external economies.

Specifically, such external economies can take two forms - (i) the

breaking of bottlenecks (like the import-export gap which was

described earlier as a production function bottleneck), and (ii)

the introduction of technical know-how by foreign investors. These

economies can accrue in the form of training technical personnel,

I ' , .L

ECA/MRAG/95/2/TP Page 19 innovation in products and production techniques which can be diffused into the rest of economy X.

Although these external economies may seen to bring an extra gains to economy X, they might conceivably reduce the gains mentioned earlier (i.e. (a), the resulting change in the wage bill;

(b) the increase in the profits or indigenous investors and, (c) the tax revenue from the profits of additional foreign capital).

Such reduction in gains may take place if the presence of foreign firms does spread the production techniques so as to enable other firms to produce the same output with their existing capital, but with less labour input. As a result, there will be a higher output, but a Lower wage bill (assuming wage rates do not change), while the prof i -ts wi 11 increase.

The above analysis assumes an improvement in the techniques of production which are heavily biased towards labour-saving rather than capital-saving. Such a situation is illustrated in Figure 7."

Figure 7.

- f:\ -

^~-

, '-

L..---.---....L---""!l'l.abo-"hnur (L)

o

ECAjMRAG/95/2/TP Page 20

In terms of Figure 7./ the external economies resulting from thei

additional increase of foreign capital flows, shift the MPPL from the full to the dotted line. Consequently, therefore, output increases by E-C-B which is positive. The wage bill decreases by A+B, and profits are up by E+A-C. Economy X will lose only if :

A + B

=

^{E + A - C}

That is, if the decrease in wage bill is equal to the profit ,

gained. However, i t would appear that economy X will get a large proportion of the latter, either in the form of taxes or in profits; Le. 1- c.(l-t) of the foreign ·investors' gain, where "c"

is the ratio of foreign to total cap"i tal, and "t" the rate of taxation

em

profits. Hence, economy X will lose only if :

A + B > 1 - c (l-t) of capital gains.

;

In the final analysis, i t seems likely that external economies (other than economies of scale) resulting from further increases in private capital inflows from abroad will increase economy X's income. There is no a prior reason why the external economies should be biased towards labour-saving rather than capital-saving.

Further gains will attract more labour from the traditional sector of the economy X.

IV. CONCLUSION.

It is hoped that from the examination of the nature and magnitude of effects and role of foreign capital flows on economy in this paper some conceputal framework for analysing the data and information on the activities of private foreign capital flows into developing economies has been provided. It should be pointed out that the analytical framework suggested in t.his paper is not intended 'to be final or dogmatic, particUlarly as the problems

, 11_,

ECA/MRAG/95/2/TP Page 21 statistical data and adequate information in the developing economies on foreign capital flows may call for some flexibility in the methodology and approach to some of the problems that have been addressed.

There is no doubt that the future of foreign capital flows into developing economies shall depend on the costs and benefits of such flolors, the role assigned td the private sector in the development plans and programmes of such economies and many other non-qualifiable factors such as the appropriate "investment climate", "investment incentives" etc.

It is, of course premature to draw even tentative conclusions from the issues that have so far have been analyzed, particularly as the magnitude of the benefits and cost of foreign capital

investmen1: could be known only atter some empirical work has been carried out to sort out the various effects analyzed in this paper.

ECA/MRAG/95/2/TP Page 22

FOOTNOTES

1. R. Nurkse, Problems of Capital Formation,in Underdeveloped Coun1:ries. Blackwell, Lon:ion, 1953, p , 121.

2. Some examples include

c.

P. Kindleberger, International Economics. Irwin, 1953, p. 323; P. T. Ellsworth, The International Economy. MacMillan, 1950, p. 124; G. HaberleI', The ~Pheonof International Trade. MacMi Han, 1 93 7, p . 5.

3. The market interest rate now paid i'by Commercial Banks on deposits in many developing countries is 4.5%, whilst similar banks in Canada are paying 6% to 7%"~

4. Simon Kuznets, "International Difference in Capital Formation and Financing", in Capital Formation -An9 Economic Growth, National Bureau of Economic Research, Princeton University Press, 1955, pp. 34-35.

5. H. Chenery and M. Bruno, "Development. Alternatives in an open Economy: The Case of Israel", Economic JOuI:nal.... 1962, pp , 79- 103.

6. Sir D. MacDougall, "The Benefits and Costs of Private Investment from Abroad: A Theoretical Approach", Economic Record. Vol. 34, no. 73, March, 1960.

7. H. W.. Ardat, "Overseas Borrowing - The New Model", Economic

Rec~:d. Vol. 33, N°.65, August, 1957.

8. It is assumed here that labour may produce any substantial output without capital. If i t can, then such output will be added to the amounts shown for both total output (EACF), and total real wages (DEF).

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ECA/MRAG/95/2/TP Paqe 23

9. Here the elasticity of demand for foreign capital is defined as the percentage increase in the stock of foreign capital associated with a one percentage fall in its marginal product.

10. Some of these include: A.K. Caincross, "The Contribution of Foreign and Domestic Capital to Economic: Development", in International Journal of Agrarian AffairE4 April, 1961; J.

Knapp, "Capital Exports and Growth", Economic Journal Sept'3mber, 1957; C. Wolf and S. C. sur ri n , Capital Formation and Foreign Investment in Underdeveloped Countrie~, Syracuse University Press, N.Y., 1955; H. Fuhrer, "The Role of Private Foreign Investment in Economic Development", Obsex-ver , OECD, Sept'3mber, 1966; J. Adler, (ed.) Capital Movements and Economic Development. I.E.A., MacMillan Lt.d., London, 1967.

11. Examples of such studies include, C. P. Kindleberger, American Business Abroad. New Haven, 1969, (especially chap. 5); R. S.

May, "Direct Investment in the LDC's: British and American", Journal of Development Studies, April, 1968; Kathleen M.

Langley, liThe External Resource Factor in Nigerian Economic Development", Nigerian Journal of Economic and Social Sciences, Vol. 10, n ", 2, July, 1968; Inter-American Development Bank, Multinational Investment in Economic Development and Integration in Latin America. Bogota, April, 1968.

12. Sir MacDougall, op.cit., p. 33.

13. It assumed that the capital can produce no output if there is no labour. This is analogous to the assumption mentioned in footnote 8.