Firm heterogeneity, foreign direct investment and the host-country welfare: Trade costs vs. cheap labor
Whether higher productivity of the foreign firm increases host country welfare depends on whether the reason for foreign direct investment (FDI) is to save the trade cost or to get the advantage of cheap labor. We show that, if the reason for FDI is to get the advantage of cheap labor, higher productivity of the foreign firm may reduce host-country welfare. Higher productivity of the foreign firm always increases (may reduce) host-country welfare if the reason for FDI is to save trade cost, while the trade cost implies transportation cost (tariff). Thus, the present paper compliments the recent literature in international trade that explores the effects of the foreign firms’ productivities on the incentives for FDI.
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