Foreign Direct Investment, Employment Volatility and Cyclical Dumping

This paper analyses 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. Labour is risk averse and immobile across countries, and entrepreneurs are risk neutral. Labour employment and income are 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 labour-intensive industries. FDI is shown both to improve welfare, and to increase the incidences of cyclical dumping. Copyright @ 1996 by John Wiley & Sons, Ltd. All rights reserved.