Using a simple model of real capital flows, Günther Schulze examines political and economic determinants of capital export controls. In Discussion Paper No. 1394, he shows that individuals vote according to their factor endowment ratio. The individually optimal restriction depends on the individual’s capital-labour ratio, the country size and whether unemployment prevails. Schulze shows how the effect of majority voting on capital controls relates to a welfare-maximizing policy in the traditional sense under both full employment and unemployment.

Capital export restrictions make capital more abundant domestically, thereby increasing the wage rate and lowering the return to capital at home. For a small open economy, unrestricted capital export is socially welfare-maximizing, whereas for a large economy there exists an optimal restriction on capital export. An individual, however, will only coincidentally support the welfare-maximizing policy: they will favour an even tighter restriction if their capital-labour endowment ratio falls short of the figure for the economy and vice versa. Since preferences are single-peaked, majority voting results in the median voter’s optimal restriction, which would be typically more restrictive than the benevolent dictator’s policy. However, if illegal immigration is introduced into the model, results are dramatically reversed: the conflict of interests collapses and all individuals favour unrestricted capital exports until immigration is eliminated – regardless of their relative factor endowment.

Capital Export, Unemployment, and Illegal Immigration
Günther G Schulze