Suppose that U.S. mutual funds suddenly decide to invest more in Canada. a. What

Question

Suppose that U.S. mutual funds suddenly decide to invest more in Canada. a. What happens to Canadian net capital outflow, Canadian saving, and Canadian domestic investment? What is the long-run effect on the Canadian capital stock? How will this change in the capital stock affect the Canadian labor market? Does this U.S. investment in Canada make Canadian workers better off or worse off? Do you think this will make U.S. workers better off or worse off? Can you think of any reason the impact on U.S. citizens generally may be different from the impact on U.S. workers?

Explanation / Answer

a.   When U.S. mutual funds become more interested in investing in Canada, Canadian net capital outflow declines as the U.S. mutual funds make portfolio investments in Canadian stocks and bonds. The real interest rate declines, thus reducing Canada’s private saving, but increasing Canada’s domestic investment. In equilibrium, Canadian net capital outflow declines.

b.   Because Canada's domestic investment increases, in the long run, Canada's capital stock will increase.

c.    With a higher capital stock, Canadian workers will be more productive (the value of their marginal product will increase) so wages will rise. Thus, Canadian workers will be better off.

d.   The shift of investment into Canada means increased U.S. net capital outflow. As a result, the U.S. real interest rises, leading to less domestic investment, which in the long run reduces the U.S. capital stock, lowers the value of marginal product of U.S. workers, and therefore decreases the wages of U.S. workers. The impact on U.S. citizens would be different from the impact on U.S. workers because some U.S. citizens own capital that now earns a higher real interest rate.

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