TEL  Vol.2 No.4 , October 2012
A Macroeconomic Consequence of Foreign Direct Investment: The Welfare Economics of Industrial Hollowing
Author(s) Masayuki Otaki*
ABSTRACT
This article considers macro and welfare economic implications concerning foreign direct investment under a flexible exchange rate system. There are serious conflicts between foreign-invested firms and their home country as a whole. Although lower wages incentivize firms to obtain foreign direct investment, such a movement harms the welfare of the home-country’s economy in the following ways. First, an increase in unemployment in the home country worsens the economy’s welfare as proved by Otaki [1]. Second, an appreciation in the real exchange rate, which is induced by the transfer of earned profits in foreign countries to the home country, reduces the value of profits in terms of domestic goods. We prove that such an appreciation entirely cancels the benefit from the cost reduction that originates from the foreign direct investment in lower-wage countries. In the end, only the downturn in employment circumstance remains. In this sense, the glut of foreign direct investment is harmful and, some coordination is required between firms and the government of the home country.

Cite this paper
M. Otaki, "A Macroeconomic Consequence of Foreign Direct Investment: The Welfare Economics of Industrial Hollowing," Theoretical Economics Letters, Vol. 2 No. 4, 2012, pp. 412-417. doi: 10.4236/tel.2012.24076.
References
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[3]   M. Otaki, “A Pure Theory of Aggregate Price Determination,” Theoretical Economics Letters, Vol. 1, No. 3, 2011, pp. 122-128. doi:10.4236/tel.2011.13026

[4]   M. Otaki, “A Keynesian Model of a Small Open Economy under a Flexible Exchange Rate System,” Theoretical Economics Letters, Forthcoming.

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[7]   R. E. Caves, “Multinational Enterprise and Economic Analysis,” Cambridge University Press, Cambridge, 1982.

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[9]   M. C. Kemp, “The Pure Theory of International Trade,” Prentice-Hall, Englewood Cliffs, 1964.

[10]   R. F. Kahn, “The Relation of Home Invest to Unemployment,” Economic Journal, Vol. 41, No. 162, 1931, pp. 173-198. doi:10.2307/2223697

 
 
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