Capital Mobility—Resource Gains or Losses? How, When, and for Whom?

• DOI: http://doi.org/10.1111/jpet.12145
• Published date: 01 June 2016
• Author: HIKARU OGAWA,YASUHIRO SATO,JUN OSHIRO
• Date: 01 June 2016

CAPITAL MOBILITY—RESOURCE GAINS OR LOSSES?

HOW,WHEN,AND FOR WHOM?

HIKARU OGAWA

Nagoya University

JUN OSHIRO

Okinawa University

YASUHIRO SATO

Osaka University

Abstract

This paper investigates which of the two types of countries—resource-

rich or resource-poor—gains from capital market integration and

capital tax competition. We develop a framework involving vertical link-

ages through resource-based inputs as well as international fiscal link-

ages between the two types of countries. Our analysis shows that capital

market integration causes capital flows from resource-poor to resource-

rich countries and improves global production efficiency. However,

such gains accrue only to resource-poor countries, and capital mobility

might even negatively affect resource-rich countries. Furthermore, we

show that resource-rich countries can exploit the gains when taxes on

capital are available.

1. Introduction

In the past few decades, we have observed drastic increases in capital flows between re-

gions and countries. Such capital movements have provoked intensive discussions on

the direction of capital movement and government reaction to capital flows. Numerous

studies have addressed these issues in the literature of tax competition theory, whose

Hikaru Ogawa, Graduate School of Economics, Nagoya University, Furo, Chikusa, Nagoya, Aichi, Japan

(ogawa@soec.nagoya-u.ac.jp). Jun Oshiro, Department of Law and Economics, Okinawa University,555

Kokuba, Naha, Okinawa, Japan (j-oshiro@okinawa-u.ac.jp). Yasuhiro Sato, Graduate School of Eco-

nomics, Osaka University, 1-7 Machikaneyama, Toyonaka, Osaka, Japan (ysato@econ.osaka-u.ac.jp).

We thank the editor, John P. Conley, the associated editor, and the referees for the valuable com-

ments and suggestions. We appreciate comments from Stephen Calabrese, Masahisa Fujita, Nobuaki

Hamaguchi, Yoshitsugu Kanemoto, Sajil Lahiri, Mutsumi Matsumoto, Harris Selod, TakatoshiTabuchi,

Chikara Yamaguchi, Kazuhiro Yamamoto, and the participants of various seminars and conferences. We

acknowledge the financial support from Research Institute of Economy, Trade and Industry (RIETI).

This work was supported by JSPS KAKENHI Grant Numbers 25245042, 25516007, 24-1393, 24730208,

22530228.

Received November 6, 2014; Accepted November 12, 2014.

C2014 Wiley Periodicals, Inc.

Journal of Public Economic Theory, 18 (3), 2016, pp. 417–450.

417

418 Journal of Public Economic Theory

long history dates back at least to Zodrow and Mieszkowski (1986) and Wilson (1986).1

The literature investigates the role of governments in attracting capital to their juris-

dictions by focusing primarily on the effects of capital tax and subsidy policies.2A sig-

nificant strand of the literature emphasizes that regions and countries differ in many

aspects and analyzes the case of asymmetric regions and countries. They place appro-

priate importance on regional disparities in, for instance, population (Bucovetsky 1991;

Wilson 1991; Kanbur and Keen 1993; Ottaviano and van Ypersele 2005; Sato and Thisse

2007), capital endowment (DePater and Myers 1994; Peralta and van Ypersele 2005;

Itaya, Okamura, and Yamaguchi 2008), and degree of market competitiveness (Ogawa,

Sato, and Tamai 2010; Egger and Seidel 2011; Haufler and Mittermaier 2011). In this

paper, we introduce an additional aspect of regional disparities—resource availability—

which is undoubtedly crucial to the production of firms but which this literature has

overlooked.3In fact, it is well known that resource availability is one of the major factors

that attract capital.4

More specifically, we explore the effects of natural resources on the distribution

of capital across countries, government reaction to capital flows, and the influence of

capital flows and tax competition on regional welfare. To this end, we develop a tax

competition model involving two countries, one of which possesses natural resources.

There are two sectors in the economy: the num´

eraire sector and the resource-based

intermediate good sector. The former is characterized by perfect competition, and its

production requires capital, labor, and intermediate goods. The latter is characterized

by oligopoly `

alaCournot, and its production requires capital as a variable input and the

num´

eraire goods as a fixed input. We focus on the circumstances in which the interme-

diate good can be produced only in places where the natural resources exist, because it

is prohibitively costly to transport the resource itself across countries.

Using this framework, we first examine the impact of capital market integration

in a laissez-faire economy (without government intervention). We demonstrate that

once the capital markets are integrated, resource-rich countries can import capital

from resource-poor countries. Although such capital movements contribute to improv-

ing global production efficiency and increasing global welfare, the gains accrue only to

resource-poor countries. In contrast, resource-rich countries may suffer from the capital

movements. We call this the resource disadvantage associated with capital market integra-

tion.5Next, we investigate the implications of a tax game in our environment. In a tax

1Wilson (1999), Wilson and Wildasin (2004), and Fuest, Huber, and Mintz (2005) provide surveys on

the literature of tax competition.

2Of course, this does not imply that the tax competition literature neglects other types of policies that

might be relevant. For example, studies such as Fuest (1995), Noiset (1995), Wrede (1997), Matsumoto

(1998), Bayindir-Upmann (1998), Bucovetsky (2005), and Cai and Treisman (2005) examined therole

of infrastructure and institutions provided by local governments to benefit production possibilities.

3To the best of the authors’ knowledge, Perez-Sebastian and Raveh (2012) are the only exception that

studies the role of natural resources in tax competition. They incorporated a competitive resource

sector into a standard capital tax competition model. However, they focus on the differences in tax

instruments available between countries, not on the resources of a particular country.

4Dunning (1993) refers to resource availability as a major factor that attracts foreign direct investment,

which is a form of capital mobility.

5Throughout the paper, the phrase “resource disadvantage” (or “resource advantage”) is defined as a

decrease (or an increase) in static welfare. The similar phrases “resource curse” and “Dutch disease” are

often multifaceted. For example, the strand of Sachs and Warner (1995) focuses on the long-term ef-

fects of resource abundance on economic growth, regardless of the transmission mechanisms; based on

Dutch-disease type arguments, Corden and Neary (1982) and Matsuyama (1992) describe a permanent

contraction of the manufacturing sector.

Capital Mobility 419

game, governments can levy a tax/subsidy on capital. In equilibrium, both countries

levy a tax on capital, the rate being higher in the resource-rich country than in the

resource-poor country. This condition is consistent with Slemrod (2004) and Keen and

Mansour (2010), who demonstrated that a resource-rich country is likely to levy higher

tax on corporate income and less likely to provide tax incentives.6In addition, this

paper shows that resource-rich countries gain from tax competition, whereas resource-

poor countries are disadvantaged by it: there is a resource advantage associated with tax

competition. Because the latter loss dominates the former gain, the tax game reduces

global welfare compared to the laissez-faire economy.

Beyond the tax competition literature, many other fields of economics recognize

the importance of natural resources. Beginning with a seminal article by Sachs and

Warner (1995), many scholars have widely discussed the impacts of natural resource

wealth on economic growth. This literature suggests that large natural resource en-

dowments can affect economic performance both positively and negatively through the

Dutch disease, institutional quality, armed conflict, volatility of commodity prices, fi-

nancial imperfection, or human capital investment.7However, none of these studies

focused on the mechanisms for transferring natural resources to the economy through

fiscal externalities arising from factor mobility. Given the increasingly pervasive influ-

ence of capital mobility and government concern about it, the aim of this study is to

provide further understandings on the features and impacts of possible interactions

among the unevenly distributed natural resources, capital mobility, and the role of

governments.

The paper proceeds as follows. Section 2 present the basic environment. In

Sections 3 and 4, we examine the effects of capital market integration without govern-

ment intervention and the effects of tax competition, respectively. Section 5 discusses

the robustness of our main results against possible extensions, and Section 6 concludes.

2. The Basic Settings

Consider two countries (country 1 and country 2), each of which has a representative in-

dividual of measure one possessing two factors of production, labor (L) and capital (K).

Each factor endowment in each country is fixed at unity. The assumption of symmetric

factor endowments is relaxed in Section 5.5. We assume that individuals are immobile

between countries and inelastically supply their labor in their country of domicile. In

the following, we consider two scenarios in which capital is either immobile or mobile.

In the first case, all factor markets are segmented; in the second case, individuals can

freely choose where to supply their capital, such that both labor markets are segmented

but the capital markets are integrated. We first compare these two cases without taxa-

tion, and then introduce the tax game to the case with mobile capital.

Two goods are produced, a num´

eraire good (X) and a resource-based intermediate

good (Z) (e.g., petroleum, steel, and minor metals). X-good is produced using capi-

tal, labor, and the intermediate good (Z-good) as inputs under perfect competition.

The production of Z-good requires capital as a variable input and X-good as a fixed

6However, a controversy exists over the robustness of this empirical finding. Dharmapala and Hines

(2009) concluded that without good governance, higher corporate tax rates are not observed in the

data of resource-abundant countries.

7The literature on the so-called “natural resource curse” is comprehensively reviewed by Frankel (2010)

and van der Ploeg (2011). For an overview of the recent empirical literature, see Torvik (2009) and

Rosser (2006).