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Foreign Direct Investment, Employment Volatility and Cyclical Dumping

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  • Joshua Aizenman

Abstract

This paper analyzes the impact of foreign direct investment (FDI) on the patterns of cyclical dumping (exporting at a price below marginal cost). We consider a global economy where manufacturing is monopolistic-competitive, and productivity is subject to country- specific shocks. Labor is risk averse and immobile across countries, and entrepreneurs are risk neutral. Labor employment and income is governed by implicit contracts, which offer stable real income and volatile employment. Capacity investment is irreversible, and is done prior to the resolution of uncertainty. If investment in manufacturing capacity is characterized by returns to scale, higher volatility of productivity shocks is shown to induce producers to diversify internationally by means of FDI. The resultant integrated equilibrium is characterized by greater volatility of employment, as the multinational effectively reallocates employment from a low- realized-productivity to a high-realized-productivity country. We derive a simple condition characterizing cyclical dumping -- it occurs when the percentage shortfall of the realized employment exceeds Lerner's ratio of market power (the inverse of the demand elasticity). Cyclical dumping is more frequent in more competitive and more labor- intensive industries. FDI is shown both to improve welfare, and to increase the incidences of cyclical dumping.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4683.

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Date of creation: Mar 1994
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Publication status: published as International Journal of Finance & Economics, Winter 1996, vol. 10: 1-28.
Handle: RePEc:nbr:nberwo:4683

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  1. Dixit, Avinash K & Stiglitz, Joseph E, 1975. "Monopolistic Competition and Optimum Product Diversity," The Warwick Economics Research Paper Series (TWERPS) 64, University of Warwick, Department of Economics.
  2. Matusz, Steven J, 1985. "The Heckscher-Ohlin-Samuelson Model with Implicit Contracts," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1313-29, November.
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Cited by:
  1. Lee, Hsiu-Yun & Lin, Kenneth S. & Tsui, Hsiao-Chien, 2009. "Home country effects of foreign direct investment: From a small economy to a large economy," Economic Modelling, Elsevier, vol. 26(5), pages 1121-1128, September.

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