Reference no: EM132336484

Question

The confidence in a country's legal system, as well as political stability within its boundaries, not only affect its exchange rate through trade, but also through the supply of foreign direct investment in that country.

Foreign direct investment is another form of "import". When Ford Motor Company opens a plant in Mexico it actually imports Mexico's labor and resources. For Ford to operate in Mexico, it needs to purchase/lease a land, pay labor wages, and pay for variable costs in Peso. So, Ford Motor Company will need to purchase Pesos for dollars, which means it will supply the market with dollars and increase the demand for Pesos. This is the same mechanism as if Ford Motor Company would import cars from Mexico. At the same time, Ford Motor Company would need to buy dollars and sell Pesos to transfer profits to its headquarter in the US and/or to pay for inputs imported from the US. In such, the stability of exchange rates between the US and Mexico is important to Ford Motor over time and any drastic changes in the exchange rates could either hurt its bottom-line (lower value of dollar compared to Peso during initial investment-buying land) or improve it (lower value of dollar compared to Peso when transferring funds to the US).

Given the above argument, which is more beneficial to the US economy:

• Encouraging American producers to move some of their production operations outside the US if higher return and lower costs are expected by operating outside the US?
• OR encouraging foreign investors to move their operations to the US?
• Pick one option and discuss how it would benefit/hurt output in the economy (GDP), employment, exchange rates, and net export.