FDI in Emerging Economies: An analysis in a firm heterogeneity model

Author Name ITO Koji  (Consulting Fellow, RIETI)
Creation Date/NO. June 2011 11-E-055
Research Project Study of the Creation of the Japanese Economy and Trade and Direct Investment
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In recent years, Japanese manufacturers in both competitive and less competitive sectors have penetrated emerging economies, and sales in 2008 by Japanese affiliates established via foreign domestic investment (FDI) exceeded Japan's revenues from exports. To consider this phenomenon and the significance of FDI for emerging economies, this study constructs a two-country model featuring two factors of production, two industries (with different factor intensities), and firm heterogeneity. Thereafter, the study numerically analyzes trends in FDI by industry and examines how the economies of both countries are affected.

Results of the analysis show that highly productive firms favor FDI. That is true whether their industries make intensive use of a scarce factor of production or use a more abundant factor intensively.

Compared to the situation in which only export is possible, FDI increases competition among firms in both industries. Real wages and welfare increase as a result. On the other hand, low-productivity firms are forced to exit, and the number of firms decreases. This analysis also shows that FDI could work to help prevent a decline in real revenues of industries that make intensive use of a scarce factor of production.