Human capital and FDI: Development process of the developing country in an overlapping generation model

Abstract

We construct an overlapping generation model with human capital accumulation to analyze the effect of human capital level on foreign direct investment (FDI) in a small open developing country. In particular, we assume that manufactured goods have the human capital intensive technology and young agents choose whether to work or to educate themselves. When the human capital level in the developing country is sufficiently small, manufactured goods firms do not conduct FDI and the economy in the developing country is trapped in poverty. If the government of the developing country levies a tariff on the imports of manufactured goods, manufacturers conduct FDI, and the economy in the developing country can escape from the poverty trap.

Keywords:

• FDI
• overlapping generations model
• poverty trap

JEL Classification:

• F43
• O15
• O40

Acknowledgements

We are grateful to Koichi Futagami for his considerable help. We also thank Ken-ichi Hashimoto, Jota Ishikawa,Yukio Karasawa, Yoshiyasu Ono and seminar participants in Nagoya University and in Osaka University. We acknowledge the financial supports of the MEXT Grant-in-Aid for Young Scientists (B).

Notes

1. Zhuang (2005) demonstrate this using Chinese data. Blomstrom and Kokko (2003) and Majeed and Ahmad (2008) confirm this in a comparison between East Asia and South America.

2. Balasubramanyam, Salisu, and Sapsford (1999) estimate the effect of FDI on the economic development on the basis of endogenous growth model.

3. Many studies suggest the relationship between human capital accumulation and the poverty trap theoretically. Azariadis and Drazen (1990) show that this relationship occurs by spillovers from human capital formation. Galor and Zeira (1993) explain this relationship by credit constraint.

4. From Basu and Van (1998) and Basu (1999), this assumption is defined as substitional axiom.

5. A justification for the increasing returns to human capital is externality of average human capital. The production function with the externality of human capital is given by Y_t(j) = L_{M, t}(j)H_tℏ^α_t, where ℏ_t denotes the average human capital in this economy at time t. From the profit maximization problem, p_t(j) = w_tℏ^{1 − α}_t. In the equilibrium, because ℏ_t = H_t, (18(18) ) can be obtained.

6. In the studies of Markusen and Venables (1998) and Cerina, Morita, and Yamamoto (2013), firms have to pay fixed costs when they conduct FDI. However, in this paper, we assume that manufacturers do not have to pay fixed costs when they conduct FDI for simplicity. If, in our model, we assume that FDI has a fixed cost, the condition which firms conduct FDI is that their profits when they conduct FDI is larger than that when they export. Because the profits when they export is decreasing in the tariff rate, we can obtain the same results whether we assume that FDI has a fixed cost or not. In addition, if the fixed cost is sufficiently large compared to the market demand in the developing country, firms have no incentive to conduct theFDI. Then, we have to assume that the fixed cost is smaller than the market demand in the developing country.

7. The other conditions of and will be used in the next subsection.

8. Please see the definition of developing countries in the appendix table of Baroo and Lee (2013).

9. When , is zero. Then, ϝ(l_t, H_t) is negative. Therefore, when , and Z(0, H_t) > Z(1, H_t) holds.