Heterogeneous Multinational Firms and Productivity Gains from Falling FDI Barriers

During the recent decade of declining foreign direct investment (FDI) barriers, small domestic firms disproportionately contracted while large multinational firms experienced a substantial growth in Japan's manufacturing sector. This paper quantitatively assesses the impact of FDI globalization on intra-industry reallocations and its implications for aggregate productivity. We calibrate the firm-heterogeneity model of Eaton, Kortum, and Kramarz (2011) to micro-level data on Japanese multinational firms facing fixed and variable costs of foreign production. Estimating the structural parameters of the model, we demonstrate that the model can strongly replicate entry and sales patterns of Japanese multinationals. Counterfactual simulations show that declining FDI barriers lead to a disproportionate expansion of foreign production by more efficient firms relative to less efficient firms. A hypothetical 20% reduction in FDI barriers yields a 30.7% improvement in aggregate productivity.