Dynamic Impacts of Trade Liberalization on Foreign Direct Investment

This study presents a simple prototype of an Applied General Equilibrium (AGE) model of global trade that incorporates the forward-looking decisionmaking on investment made by Multi-National Enterprises (MNEs) for maximization of total profit of group companies. The model can be used to clarify changes in the patterns of Foreign Direct Investment (FDI) in a general equilibrium framework in which labor wages are endogenously determined. In the study, we perform simulations to examine questions on liberalizing trade between Japan and ASEAN members where the trend of FDI is important. The simulation results revealed that: (1) trade liberalization between Japan and ASEAN 4 increases FDI to the partner country/region, and the MNEs established outside the union change the destinations of FDI from the members to other non-members; (2) increases in FDI to the partner countries/regions do not reduce domestic production volumes in Japan and ASEAN 4; (3) excess production of Japanese companies in ASEAN 4 lowers the cost of intermediate inputs, and resultant depreciation of output prices of goods enables households in every country/region except China to consume more; and (4) since the product of Japanese companies operating in ASEAN 4 is a kind of rivalry with Chinese tradable for other countries/regions, the excess supply of the product of Japanese companies in ASEAN 4 partially eliminates the Chinese product from the market, and makes China be worse off.