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.

Answer 1

Advantages of capital flow across the world:
Increasing aggregate demand: Capital flow is an important component of aggregate demand. High level of capital flows will boost investment which will lead to economic growth. And this will also reduce the unemployment level
Increasing the rate of productive capacity: As investment increased through high level capital flows will increase the productive capacity. This with shift the aggregate supply to right.
Improvement in technology: The improved economic growth will leads to the introduction of new working methods and technology. This improves labour relations. This will increase the labour productivity also.
Lowering the prices for consumers: High level of investment from foreign countries will enhance the efficiency of production and this will leads to low level prices in domestic firms
Disadvantages of capital flows:
Potential capital out flows: If foreign firms increase the capital holdings in domestic countries means that they are more dependent towards other countries
Tax avoidance: large multinational companies having lower corporate tax rates. This will lead to the fall in overall tax rate in the world. And this make burden on consumers and works
Distorted asset markets: Capital inflows comprise of trading in property and assets. This will lead to overheat in the property market, which push the property prices.