Foreign Capital Inflow and Regional Immiserization

In recent years a number of papers have examined the impact of inflow of foreign capital on welfare in a trade theoretic model. Two fundamental ques - tions have been raised in this literature. First, what is the welfare impact of foreign capital inflow under a laissez faire regime? Second, what is the impact of tariff induced capital inflow on welfare? In this paper we depart from the Heckscher-Ohlin framework where there is only one representative agent whose welfare is considered. We exploit a trade theoretic framework to analyse the impact on an inflow of foreign capital on regional welfare, in particular, urban and rural incomes. The analysis is undertaken in a four goods, two region model where each region produces and consumes its own non-traded good. Foreign capital is only used in the urban region and its inflow is treated initially as exogenous and later endogenised via a movement in the terms-of-trade. An exogenous inflow of foreign capital necessarily raises aggregate urban income irrespective of capi - tal intensity conditions. The rural region is ‘immiserized’ by the inflow of for - eign capital provided that the rural traded good is more capital intensive than the rural non-traded good. In this framework rural employment always falls and urban employment always rises. In the case where foreign capital inflow is induced by a change in the terms-of-trade, immiserization may occur in both regions depending on the capital intensities in all sectors. This paper highlights the locational implication of the inflow of foreign capital.