The relative roles of domestic and foreign capital in aggregate production of GDP and CO2-equivalent emission across OECD countries

This paper adopts a two-stage stochastic frontier analysis framework to analyse the roles of foreign and domestic capital in the aggregate production of gross domestic product (GDP) and CO2-equivalent emissions across 36 OECD countries from 1990 to 2014. The first stage estimates a quadratic output directional distance function to derive the marginal products of foreign and domestic capital with respective to GDP and emissions. The second stage examines explanations for variations in the marginal rate of technical substitution (MRTS) of foreign and domestic capital across OECD countries. Our paper finds two important empirical evidence findings on the role of foreign capital in the aggregate production of desirable and undesirable outputs. Firstly, that foreign capital appears to be more effective than domestic capital in generating GDP and curbing CO2-equivalent emissions. We find that one standard deviation of GDP (or $2333 billion in 2011 dollars) would require $1857 billion (in 2011 dollars) of foreign capital in comparison with $4867 billion of domestic capital, ceteris paribus. On the other hand, the reduction of CO2-equivalent emissions by one standard deviation would demand $4091 billion (in 2011 dollars) of foreign capital relative to $16,539 billion of domestic capital. Second, foreign capital is more effective in reducing emissions in countries characterised by higher GDP per capita, larger population density, and higher shares of manufacturing sectors and exports.