Question

Suppose that the United States initially has a lower capital rental rate (r) than Mexico.

• What would be the direction of foreign direct investment (FDI)?
• Use a world-capital-market graph to show the effects of FDI on the two countries’ rental rates of capital, GDP, and total return to labor owners.
• Identify the net change in world output in the above graph.
• If the source country restricts the amount of outward FDI, how would the net change in world output identified in part (c) above be affected? Illustrate your answer in the same graph above.
• Discussion: what policy could governments use to attract inward FDI? What are the tradeoffs of such policy?

Answer 1

Initially the United States has lower capital rental rate than the Mexico. This changes the foreign direct investment of USA and Mexico. Foreign direct investment refers to the investment made by one country into company of another country. Foreign direct investment (FDI) is an important part of economic connection between United States and Mexico after the implementation of NAFTA. The USA companies are the largest source of FDI in Mexico.  
The effect of FDI on the rental rate of capital of USA and Mexico is increasing the currency value. The rise in FDI leads to more demand of currency of receiving country in another country. This helps in improving the exchange rate and trade which is the ratio of exports and imports. According to the data and conferences, US trade development pulled 25% less in FDI and this effects the exchange rate all over the countries. Mexico is one of the giant countries having highest FDI in last decade at a rank of 15.
The outward FDI refers to a business policy in which the local firms expand its working to the foreign country. This will helps to enter new markets and to import intermediate goods from the foreign markets at low rate and also it benefits the domestic firms by increasing the competitiveness among the firms.
To reduce the restrictions on FDI, the government needs to provide transparency for all kinds of firms either domestic or foreign. This will helps in sooth working of business, access to imports, flexible labor markets and intellectual rights. This will improves the employment conditions, human resource development, economic growth, improved capital flow, exchange rate stability, increase in exports etc.