Effects of Direct Foreign Investment in the Presence of Sector-Specific Unemployment

This paper analyzes the effects of foreign investment on a Harris-Todaro economy. It is shown that inflows of foreign capital in the manufacturing sector may decrease or increase unemployment. In the absence of another distortion foreign investment necessarily improves the welfare of the small economy independently of the pattern of trade. This paper identifies the conditions that determine the direction of change of national welfare, in the presence of a tariff and unemployment. Import substitution strategies are more likely to improve welfare and increase employment in countries characterized by a high ratio of urban to rural employment.

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