The barter theory of international exchange remains incomplete until the complications arising from the presence of international investment are explored in our standard two-good, two-factor model. This is the task assigned to this chapter. In all, this chapter is concerned with two burning issues. First, it turns out that under certain conditions free international movement of capital is a perfect substitute for free inter-country movement of goods. In other words, the hitherto assumed absence of international immobility of factors turns out to have been made not for convenience but for ensuring that trade will in fact take place among countries. However, the conditions under which capital movement becomes a perfect substitute for goods movement are quite stringent, and it is not at all unlikely to encounter the presence of international movement of both goods and capital. This gives rise to our second question, namely, what are the optimal policies in the presence of trade and international investment? The model described below is a natural extension to the case of international investment of the two-good, two-factor model that we have been using in the past several chapters.
KeywordsHome Country Optimal Policy Foreign Investment Free Trade Capital Mobility
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