Job-search and foreign capital inflow - a three sector general equilibrium analysis

The purpose of this paper is to extend the Fields’ (1989) multi sector job-search model in a three sector general equilibrium framework by introducing international trade and an input, capital. The three sectors are the rural sector, the urban informal sector and the urban formal sector. The rural sector and the urban informal sector use one type of mobile capital while the urban formal sector uses sector-specific another type of capital. We find that the effects of the inflow of foreign capital in the urban formal sector on unemployment and social welfare crucially hinge on the relative factor intensities of the rural and the urban informal sectors. We show that there is a possibility of a trade-off between the government’s twin objectives of improvement in social welfare and mitigation of the urban unemployment problem. These results are extremely crucial from the view of policymaking in an unemployment plagued, low-income developing economy.