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Capital Flow, Foreign Direct Investment and Home Market Effect

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  • Naohisa Hirakata

    (Director and Senior Economist, Institute for Monetary and Economic Studies (currently, Financial System and Bank Examination Department), Bank of Japan (E-mail: naohisa.hirakata@boj.or.jp))

  • Mitsuru Katagiri

    (Associate Director and Economist, Institute for Monetary and Economic Studies (currently, Monetary Affairs Department), Bank of Japan (E-mail: mitsuru.katagiri@boj.or.jp))

Abstract

In this paper, we investigate the dynamics of foreign direct investment (FDI) and examine the effects of FDI on the macroeconomic dynamics following a decline in labor endowment. In so doing, we introduce capital accumulation into Helpman, Melitz and Yeaple (2004)'s model and extend their model to a dynamic setting following Ghironi and Melitz (2005). Our main findings are as follows. First, we find that FDI stocks do not monotonically decrease toward the new steady state but rather initially increase and move away from the new steady state before reversing course and converging to it, reflecting the fact that a part of foreign assets is accumulated in the form of FDI. Second, we find that foreign portfolio investment (FPI) helps the funding of foreign multinational firms and encourages inward FDI by them. While the increase in inward FDI decreases the number of domestic firms by discouraging their entry, it increases the equilibrium relative wages, thus making the relationship between relative wages and the number of firms different from the conventional "home market effect.''

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Bibliographic Info

Paper provided by Institute for Monetary and Economic Studies, Bank of Japan in its series IMES Discussion Paper Series with number 13-E-05.

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Date of creation: Jun 2013
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Handle: RePEc:ime:imedps:13-e-05

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Keywords: Foreign Direct Investment (FDI); Capital Flows; Home Market Effect;

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  1. Chang-Tai Hsieh & Ralph Ossa, 2011. "A Global View of Productivity Growth in China," NBER Working Papers 16778, National Bureau of Economic Research, Inc.
  2. Markusen, James R. & Venables, Anthony J., 2000. "The theory of endowment, intra-industry and multi-national trade," Journal of International Economics, Elsevier, Elsevier, vol. 52(2), pages 209-234, December.
  3. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1987. "International real business cycles," Working Papers, Federal Reserve Bank of Minneapolis 426, Federal Reserve Bank of Minneapolis.
  4. Mark J. Melitz, 2002. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," NBER Working Papers 8881, National Bureau of Economic Research, Inc.
  5. Brainard, S Lael, 1997. "An Empirical Assessment of the Proximity-Concentration Trade-off between Multinational Sales and Trade," American Economic Review, American Economic Association, American Economic Association, vol. 87(4), pages 520-44, September.
  6. Chang-Tai Hsieh & Ralph Ossa, 2011. "A Global View of Productivity Growth in China," Global COE Hi-Stat Discussion Paper Series, Institute of Economic Research, Hitotsubashi University gd10-166, Institute of Economic Research, Hitotsubashi University.
  7. Natalia Ramondo & Andrés Rodríguez-Clare, 2010. "Growth, Size, and Openness: A Quantitative Approach," American Economic Review, American Economic Association, American Economic Association, vol. 100(2), pages 62-67, May.
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