On the Magnet Effect of Foreign Direct Investment

Pao-Li Chang () and Chia-Hui Lu

No 21-2006, Working Papers from Singapore Management University, School of Economics

Abstract: We extend Antras and Helpman (2004) on firm heterogeneity and organizational choice to a dynamic setting with FDI uncertainty, in which the probability of investment failure decreases with the host country's infrastructure level and increases with the technological complexity facing each firm. Moreover, it decreases over time as the accumulated mass of firms succeeding in FDI increases. We show that a minimum level of infrastructure is required to trigger a first wave of industrial migration. We then formalize the often noted "magnet effect" of FDI-the first wave of industrial migration generates positive externality (information spillover) for subsequent investors, which stimulates a second wave of industrial migration. The process continues until the power of the "magnet" reaches its steady-state level. In contrast with the predictions in Antras and Helpman (2004), we show that firms with intermediate productivity levels are the ones migrate first, while the most productive and the least productive firms tend to stay behind. This non-monotonic relationship between firms' productivity and their FDI propensities is consistent with the patterns of Taiwanese firms undertaking FDI in China.

Pages: 30 pages
Date: 2006-09
New Economics Papers: this item is included in nep-sea and nep-tra
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Published in SMU Economics and Statistics Working Paper Series

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