Capital Mobility, the Real Exchange Rate, and the Rate of Return to Capital in the Presence of Non-Traded Goods

This Paper constructs a general equilibrium trade model of a small open economy producing an exported good, an imported good and a non-traded good by using two or more factors of production, one of which, namely capital, is imperfectly internationally mobile. Within this framework, it is shown that an exogenous capital inflow may lead to a depreciation of the real exchange rate, and to an increase in both the nominal and the real rate of return to capital. For these paradoxical results to occur it is necessary that the non-traded good is capital intensive.