Capital controls and the location of industry

This paper studies capital controls on the outflow of capital in a two‐region new economic geography model. Capital controls are set in a non‐cooperative or cooperative manner by social planners. Capital controls are relatively higher in the North in the non‐cooperative equilibrium. This leads to relatively more firms located in the region where more consumers reside under the non‐cooperative equilibrium. The locational bias towards the North in the non‐cooperative equilibrium becomes larger as trade barriers are reduced. That is, firms locate to the North at a relatively higher rate in the non‐cooperative equilibrium as trade is liberalised. Contrary to previous findings, it follows that global welfare is relatively higher in the non‐cooperative equilibrium, although the social planner sets capital controls by maximising joint regional welfare in the cooperative equilibrium.