Capital Flow, Foreign Direct Investment and Home Market Effect

Naohisa Hirakata and Mitsuru Katagiri

No 13-E-05, IMES Discussion Paper Series from Institute for Monetary and Economic Studies, Bank of Japan

Abstract: In this paper, we investigate the dynamics of foreign direct investment (FDI) and examine the effects of FDI on the macroeconomic dynamics following a decline in labor endowment. In so doing, we introduce capital accumulation into Helpman, Melitz and Yeaple (2004)'s model and extend their model to a dynamic setting following Ghironi and Melitz (2005). Our main findings are as follows. First, we find that FDI stocks do not monotonically decrease toward the new steady state but rather initially increase and move away from the new steady state before reversing course and converging to it, reflecting the fact that a part of foreign assets is accumulated in the form of FDI. Second, we find that foreign portfolio investment (FPI) helps the funding of foreign multinational firms and encourages inward FDI by them. While the increase in inward FDI decreases the number of domestic firms by discouraging their entry, it increases the equilibrium relative wages, thus making the relationship between relative wages and the number of firms different from the conventional "home market effect.''

Keywords: Foreign Direct Investment (FDI); Capital Flows; Home Market Effect (search for similar items in EconPapers)
JEL-codes: F12 F23 F32 (search for similar items in EconPapers)
Date: 2013-06
New Economics Papers: this item is included in nep-int
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