Foreign trade and per capita income: new evidence for Latin America and the Caribbean: Humberto Ríos-Bolívar and Omar Neme- Castillo
Thus, integration represents two options. First, national firms within the value chain of MNCs that invest abroad, update their technological capacities, generating a ‘catching up’ effect on the domestic economy. Second, stronger trade links between these economies mean that MNCs from an advanced country that employ knowledge, processes, organisational methods, distribution networks, etc., in domestic production, impact to some extent on product growth rate, without necessarily disseminating that knowledge and, therefore, without contributing to human capital formation of the domestic economy. W is included in the model because it depends on foreign investment in capital formation and in systematic R&D activities, which reflects higher productivity levels than the domestic ones. W is understood as expenditures made by other countries in order to build their production capacities, which are nevertheless exported, at least partially, to less developed economies through FDI and represents the available stock that helps them to produce more efficiently, without incurring additional costs. W is interpreted as the international knowledge spillover restricted to related MNCs. That is, knowledge of these firms, or part of them, is limited; it does not flow either with speed or with magnitude one could think if it were a pure public good. Knowledge spillover is partially restricted to links between matrix and subsidiaries of MNCs, which affect the production capacity of host economies of FDI and, ultimately, their growth rate. Thus, trade integration affects income by two different ways. First, to the extent agents in the foreign economy are capable to accumulate physical and technological capital financed by savings. Second, by FDI which operates through MNCs in the domestic economy, namely, to the extent that activities of such companies grow in relation to the national market, firms will import part of this capital stock from their country of origin, with a growing effect in host country output. Formally, dW/dt = (dK/dt)·Λ, where s and Y are the rates of savings and income of the foreign economy (i), respectively, which determine technological capital accumulation in that country; Λ = (FDIij/VDj), is the diffusion rate of this knowledge abroad, where FDIij is foreign direct investment from country i to j and VDj is domestic sales in j. Thus, the second term on the right side represents the share of MNCs that use their ‘know how’ to produce domestically. The magnitude of the ‘spread’ of physical and technological capital by MNCs in foreign markets depends on accumulated amount available in their country of origin. The stock of foreign capital ‘imported’ indirectly is increasing in both terms. On the other hand, human capital can be accumulated by three different ways: education investment, ‘learning-by-doing’ and international knowledge spillover. In the first case, human capital formation through investment in education implies that the share of income a country invests in education infrastructure creates human capital (H). The same production function of physical capital applies to human capital (Mankiw et al., 1992). H is accumulated through investment in education (Ih) which is financed by saving (Sh), that is, dH/dt = Ih = Sh = sh·Y.