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Industrial Hollowing Under a Flexible Exchange Rate System

In: Keynesian Economics and Price Theory

Author

Listed:
  • Masayuki Otaki

    (The University of Tokyo)

Abstract

This chapter considers the welfare implications of foreign direct investment (FDI) under a flexible exchange rate system, from the viewpoint of a macroeconomic theory. With FDI there can be a conflict between individual firms and the national economy as a whole. Although lower wages may be an incentive for firms to take advantage of FDI, the resulting economic surge may harm the national economy. This comes about first because an increase in unemployment in the home country will reduce that economy’s welfare, and second, an appreciation in the real exchange rate, caused by the remittance of earnings from foreign countries, will reduce the value of profits in terms of domestic goods. This appreciation entirely cancels the benefit from the cost reductions that induce FDI in lower-wage countries, and only the downturn in employment remains. In this sense, a glut in FDI is harmful, and some coordination is required between firms and their government to reduce its effects.

Suggested Citation

  • Masayuki Otaki, 2015. "Industrial Hollowing Under a Flexible Exchange Rate System," Advances in Japanese Business and Economics, in: Keynesian Economics and Price Theory, edition 127, chapter 9, pages 107-116, Springer.
    • Handle: RePEc:spr:advchp:978-4-431-55345-8_9
    DOI: 10.1007/978-4-431-55345-8_9
    as

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