A Theory of North-South Trade and Foreign Direct Investment

We analyze the steady state effect of foreign direct investment (FDI) and globalization in a dynamic general equilibrium model of North-South Trade with scale invariant growth developed by Segerstrom and Dinopoulos (2007). Here FDI is defined as the movement of production bases from the North to the South by the northern firms because the incentive of FDI is the lower production cost in the South. By our numerical analysis, the increase of exogenous FDI arrival rate leads to a higher imitation rate in the South, industry shift from the North to the South (the increase of the ratio of the southern imitation firms and multinational firms compared to the ratio of northern innovation firms) and lower wage inequality between the North and the South. But there is no change in the long run innovation rate and the decrease of short run innovation rate. On the other hand, globalization is defined here as the increase of South population. By my numerical analysis, globalization leads to less copying of Northern products, faster technological progress, more industry shift from the North to the South utilizing the increase in multinational firms, and greater wage gaps between the two regions.