Sovereign Capital, External Balance, and the Investment-Based Balassa-Samuelson Effect in a Global Dynamic Equilibrium

We develop a two-country dynamic optimization model with investment and labor mobility and calculate its full-distribution Markov solution without relying on non-stochastic steady-state shortcuts. Agents have access to so-called sovereign capital (an extension of the inside equity notion) as well as the usual outside equity in their own country, but only to outside equity in the other country. This friction creates two distinct categories of partially non-tradable investment goods. Their price ratio can be viewed as an analogue of the real exchange rate in the Balassa-Samuelson model, but with consumption goods replaced by assets. In equilibrium, this asset-based real exchange rate is more sensitive to the stock ownership split between residents and non-residents in each country's production capacity than to the ratio of national physical capital stocks. In a similar model without sovereign capital exclusivity, the order of the sensitivity is reversed. Along with the real exchange rate, we also analyze equilibrium net investment positions and financial account levels as functions of the physical capital ratio and the stock ownership splits. This allows us, in the dynamic equilibrium environment modeled, to point at the underlying regularities behind the seemingly irregular interplay between the external balance and the exchange rate.