Abstract
This paper quantitatively assesses the impact of falling foreign direct investment (FDI) barriers on individual firms and its implications for intra-industry reallocation and aggregate productivity. We calibrate the firm-heterogeneity model of Eaton et al. (Econometrica 79(5):1453–1498, 2011) to match micro-level data on Japanese multinational firms facing fixed and variable costs of foreign production. We demonstrate that the calibrated model can be used to replicate the entry and sales patterns of Japanese multinationals. Counterfactual simulations show that declining FDI barriers lead to a disproportionate expansion of foreign production by more efficient firms relative to less efficient firms. A hypothetical 20 % reduction in FDI barriers is found to generate up to a 26.8 % improvement in industry-level productivity through global market-share reallocations within the industry. Compared with fixed entry barriers, reallocation effects and productivity gains are larger for a reduction of variable costs of foreign production.
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Notes
While FDI barriers are not explicitly measurable, Gormsen (2011) estimates that FDI barriers have halved every 4.8 years and contributed to over 75 % of the growth in FDI stocks in recent decades.
Estimated worldwide sales of foreign affiliates were more than twice those of exports in 2010 (UNCTAD 2011).
For our analysis, this limitation is due to the lack of Japanese firm-level data on export sales by destination.
Blonigen (2001) finds both complementary and substitution effects for the Japanese automobile multinationals investing in the US while Yamashita and Fukao (2010) find that the overseas operations of Japanese MNEs do not reduce their domestic employment. Irarrazabal et al. (2012) find that with intra-firm trade, a reduction in FDI barriers could increase domestic activity.
The surveyed sample included 12,855 manufacturing firms with 4.9 million employees in 2006.
A foreign business is defined as one in which 10 % of the affiliate’s equity shares are owned by a Japanese parent firm.
The following results are similar when the size is measured by domestic employment or when export sales are excluded.
Between 1996 and 2006, the total volume of domestic production declined by 7.1 %, whereas foreign production increased by 98.9 %. Since the substantial growth of offshore production offset the contraction in domestic production, global production increased by 3.8 % from 464.5 to 482.0 trillion yen.
Using a different dataset on Japanese firms, Tomiura (2007) finds that multinational firms in Japan are 60 % more productive than non-multinationals.
The efficiency loss of offshore production is similar in interpretation to Keller and Yeaple (2008), showing that complex technologies deter multinational production from imports by multinational parent firms. It is also consistent with the findings in Ramondo (2012) and Ramondo and Rodriguez-Clare (2009) that multinational costs increase with distance, language barriers, and national borders.
FDI policy restrictions may increase the costs of multinationals operating abroad in terms of ownership constraints, foreign-specific regulations, and weak legal protection of property and capital (World Bank Group 2010).
The absorption is total production minus export plus import, which are taken from the World Development Indicators.
The fraction is constructed by dividing (rank −0.5) by the total number of firms/affiliates for each observation in a given market, where the rank is one for a firm/affiliate with the largest sales.
Refer to a derivation of the price in Online-Appendix 2.
The level of size dispersion is related to heterogeneity in firm efficiency via an elasticity of substitution. As Kang (2008) estimates that the elasticity of substation is 2.19 for the Japanese manufacturing sector in 1994–2004, a rough estimate of efficiency dispersion from our estimated parameter is 2.37. By contrast, Wakasugi et al. (2008) find that the dispersion parameter of total factor productivity was 1.69 for Japanese manufacturing firms in 2003.
These results are presented in Arita and Tanaka (2011).
Some limitations of the model are found in the validation exercises; large firms tend to invest in too many countries, but small firms invest in too few. Also, we tend to under-simulate the sales level of Japanese multinationals in both home and foreign markets. These findings are reported in Arita and Tanaka (2011).
FDI deficits are fixed to their 2006 levels in counterfactuals.
Falling variable barriers decrease average domestic production across all firms except for the lowest decile group, in which some smallest firms exit and the surviving firms increase domestic production. This leads to an increase in average domestic production of all firms. By contrast, declining fixed barriers increase average domestic production for all firms because wealth effects strongly expand demand for domestic production.
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Acknowledgments
We acknowledge the financial support of the Institute of Developing Economies and JSPS Grant-in-Aid for Scientific Research (B). The authors would like to thank RIETI for research opportunities and the Ministry of Economy, Trade, and Industry (METI) for providing firm-level data. For useful comments, we thank Theresa Greaney, Taiju Kitano, Naoto Jinji, Toshiyuki Matsuura, Timothy Halliday, Toshihiro Okubo, and seminar participants at the Midwest International Trade Meeting, Asia Pacific Trade Seminar, Institute of Developing Economies, Japanese Economics Association Conference, Japanese International Economics Conference, Keio University, University of Kitakyushu, and RIETI. The opinions expressed and arguments employed in this paper are the sole responsibility of the authors and do not necessarily reflect those of RIETI, METI, or any institution with which the authors are affiliated. All remaining errors are our own. The views expressed here are those of the authors and may not be attributed to the Economic Research Service or the US Department of Agriculture.
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Arita, S., Tanaka, K. Heterogeneous multinational firms and productivity gains from falling FDI barriers. Rev World Econ 150, 83–113 (2014). https://doi.org/10.1007/s10290-013-0174-1
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DOI: https://doi.org/10.1007/s10290-013-0174-1