Migrant Business Networks and FDI

statistics. Section illustrates the main findings. In Section VI some policy implications are discussed
and Section VII concludes.

II. Theoretical framework

II.1. A small developed economy

Consider a small open economy where good Y is produced according to the technology:

Yt = A(Ht)Kt^1-αL^αt                                          (1)

where A(Ht) is the total productivity of factors at time t and Ht is the average level of human capital,
or average number of efficiency units of labor in the economy. ¹ Lt =NtHt is the stock of labor
designed in efficiency units. Kt is physical capital. Skilled and unskilled workers are perfect
substitutes and markets are perfectly competitive. Equalizing to one the efficiency units
corresponding to the unskilled workers, denoting with h>1 the skill premium and with Pt the
proportion of skilled, it follows that Ht =1+Pt(h - 1). Denoting with k the capital to labor ratio,
factors’ returns of capital, r, and labor, w, are:

rt= (1 - α)A(Ht) kt^-α                                          (2)

wt =αA(Ht)kt^1-α                                            (3)

Capital is perfectly mobile in the international markets, while labor mobility is restricted by
migration costs and countries’ immigration policies. The domestic interest rate is given by the
international rate of interest augmented by a country “risk factor” which depends on a set of
variables, Zt, as corruption, political risk, credibility of institutions, civil and political rights. Hence
r_t = r + π_t, where r is the international rate of interest and π_t is the country premium, with π_t> 0.

The equilibrium capital to labor ratio and the equilibrium wage are

¹ The model is based on Kugler and Rapoport (2006), Razin, Rubinstein and Sadka (2004), Docquier and Lodigiani
(2006).

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