Should the Capital Account Be Liberalized in a Minimum Real Wage Economy?

Sebastian Edwards and Alejandra Cox Edwards in their analysis of the Chilean economic liberalization argue that both capital inflows and outflows may have harmed the Chilean economy. They model the Chilean economy as using labor and fixed factors to produce traded and non-traded goods subject to a binding real wage floor in both sectors. We formalize this model. We discover that a capital inflow may expand or contract employment. We also find that the shadow price of a capital inflow (alias the shadow price of foreign exchange) can be negative only if either the tradable or non-tradable good is inferior.