Question

It is unclear whether the free flow of capital is beneficial to all countries. Explain the benefits and costs of allowing capital to move freely. 38 4 01. # 5 12201 + 11

Answer 1

Free flow of capital is the movement of capital for the purpose of investments or research and development between nations. The advantages associated with free flow of capital are:

1. The investment in a foreign country will increase the aggregate demand of the country. The increase in investment will increase the money supply and boost the aggregate demand in the economy. There will also be a reduction in the unemployment levels as the production increases in the economy. The result of this will be that the economy achieves a higher economic growth as well.

2. The inflow of capital will also have a favourable impact on the balance of payments. A favourable balance of payments is good for any economy in the long run growth. The deficit in the balance of payments is corrected with the inflow of capital.

3. The country from where the capital flows in will also benefit as the investors will receive a higher rate of return on their investments. This will aid in the growth of that economy as well.

The disadvantages associated with free flow of capital:

1. If the individuals of an economy send capital to another nation, then it increases dependence of the economy on the foreign nation. This means that any fluctuations in the foreign nation will affect the domestic nation as well.

2. The increase in the investment which will lead to an increase in the money supply in the economy may create an inflationary pressure in the economy.