Question

There is disagreement among economists of whether the flow of capital is good or bad for a country. Explain the benefits and costs of allowing capital to move freely into a country. (Your answer should not exceed 8 lines).

Answer 1

Every economist has its own and specialised way of thinking.support Like free trade, the argument goes, the free flow of capital across borders can increase economic efficiency. Savings will flow to the most productive investment opportunities, regardless of their location; greater competition will create more nimble financial systems in every country; and vigilant investors will provide a healthy discipline for profligate governments.

The benefits of allowing capital to flow freely in a country as follows:

1. Increased Aggregate Demand As a component of AD, higher Investment will boost AD, causing improved economic growth. This should lead to lower levels of unemployment.

2. Increased productive capacity. Inward investment will not only increase AD but also increase Aggregate Supply. Investment in new factories increases productive capacity, and AS should shift to the right. This enables an increase in economic growth without inflation

3. Technological improvements. MNCs may not only invest in new capacity. They may also introduce new working practices that help increase labour productivity. For example, when Japanese firms invested in the UK, it was said that they helped to improve labour relations and get more out of the workforce. Japanese firms introduced new practices such as ‘Just in time management’ and a less confrontational attitude between workers and managers. Therefore, it can contribute to increased labour productivity

4. Surplus on the Financial Account of the Balance of Payments
Capital inflows from abroad can help to finance a current account deficit. Through attracting capital flows, it enables UK households to effectively import more goods and services. Without these capital inflows, a current account deficit would lead to a devaluation in the exchange rate to restore equilibrium in the balance of payments.

5. Lower Prices for Consumers

Investment from foreign firms offers the chance for goods to be produced more efficiently and could lead to lower prices for domestic firms.

6. Finance public sector debt

Capital flows which involve foreigners buying UK government bonds – means it is easier and cheaper for UK to finance its government borrowing

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