Comparative Advantage, Outward Foreign Direct Investment and Average Industry Productivity: Theory and Evidence

Abstract

This paper analyzes the role of comparative advantage in the effects of outward FDI on domestic productivity. In the theoretical framework, we place Helpman, Melitz and Yeaple's (2004) outward FDI model into Bernard, Redding andSchott's (2007) framework of international trade with heterogeneous monopolistically competitive firms and comparative advantage and show that the increase in outward FDI raises aggregate productivity in all industries through the intra-sectoral reallocation of firms, but this productivity growth is more prominent in a nation's comparative advantage industry. Using Korean industry-level data, we empirically test our theoretical predictions using the production function model as a benchmark model, followed by system GMM estimation methods for sensitivity analysis. Our empirical findings also suggest that outward FDI has a positive effect on domestic productivity and this link is more likely to take place in those sectors above average competitiveness measured as export-based revealed comparative advantage.

Does outward foreign direct investment improve the performance of domestic firms? Case of Korea

“…Potential OFDI firms (parent companies) can be ex-ante different from non-OFDI firms (domestic firms) before they invest in OFDI. As illustrated in 15 This is in line with the argument of Huang and Zhang (2017), Jang and Hyun (2015), and Rai et al (2018), who suggest that the intra-firm network is an important mechanism for transferring reverse knowledge to parent companies.…”

“…2 For example, Al-Sadig (2013), and Jang and Hyun (2015) support the evidence of a "crowding-out effect" on domestic investment by OFDI.…”

“…Unlike the vast literature on inward FDI, few studies have investigated how OFDI affects the productivity of parent companies in their home country. In addition, several studies examining the productivity effects of OFDI on Korea not only provide inconsistent results, but are also limited to case studies, survey approaches, and industry-level datasets (not firm-specific) (Lee, 2010;Jang & Hyun, 2015). 6 Here we provide a literature review on the role of OFDI and explain how the effects of OFDI differ by certain factors, such as market entry mode, OFDI destination, and absorptive capacity of parent companies.…”

“…The scale of OFDI effects can depend on the nature of parent companies. Many researchers emphasize the role of absorptive capacity, which plays a crucial role in determining how much a parent company can benefit from OFDI (Jang & Hyun, 2015; Li et al, 2017). Absorptive capacity speeds up the realization and application of new knowledge into practice (Vu, 2018).…”

“…For instance, Lee (2010) argues that the relationship between OFDI and labor productivity in Korea is positive but insignificant, while Jang and Hyun (2015) show a strong relationship between the two variables.…”