LAUSR

Abstract This paper presents a post Keynesian open economy model to investigate the possible effects of capital flows on capacity utilization and distribution in financially controlled and financially liberalized small open economies. In financially controlled regimes, capital flows increase labor productivity through spillover effects. The increase in labor productivity leads to a decrease in wage share of workers from national income which leads to lower prices. The lower price level in turn results in real exchange rate depreciation and provides higher trade balances through enhanced export competitiveness. In financially liberalized regimes, capital flows result in real exchange rate appreciation, which decreases the cost of foreign borrowing, foreign intermediate goods, and lower wage shares. In line with all these developments, capacity utilization increases, but trade balances deteriorate due to diminished export competitiveness.