The Impact of Declining FDI Barriers on Intra-Industry Reallocations and Aggregate Productivity Growth: A Quantitative Analysis on Japanese Multinationals

This paper quantitatively investigates the impact of falling FDI barriers on changes in intra-industry reallocations and aggregate productivity growth. Expanding on our earlier work (Arita and Tanaka 2011), we calibrate an adapted version of Eaton, Kortum, and Kramarz’s (2011) general equilibrium model of heterogeneous firms to Japanese multinational firms facing fixed and variable FDI barriers. The quantified model is based on structural parameters estimated on detailed firm-level data of Japanese manufacturing activity that was found to reasonably replicate current and past multinational entry and sales patterns. We use the model to perform several counterfactual experiments of reductions in FDI barriers to explore how the impacts that occur at the firm level are linked to changes in overall aggregate production structure. Simulating a 25% reduction in FDI barriers around the world, we find a dramatic restructuring in the Japanese economy. Due to high fixed costs and skewed distributional structure, lowering FDI barriers leads to an asymmetric expansion of multinational activity where the top 1% of firms account for 52% of all the FDI-induced expansionary growth. The significant reallocation of production activity from small firms to large firms translates into a 34% increase in aggregate productivity. We find reductions in variable barriers have more dramatic impacts on aggregate productivity growth than changes in fixed costs. Lastly, the model is used to quantitatively explore the production structure consequences of a global reduction in foreign taxes and liberalization of FDI regulations.