Outward foreign direct investment, wage rigidity and unemployment: A computable general equilibrium analysis

Abstract

Taiwan has started to liberalize its exchange rate and foreign investment policies since the mid 1980s. The subsequent considerable appreciation of its currency and increasing labor cost has stimulated many Taiwanese firms to actively undertake outward foreign direct investment (FDI). The possibility of the industrial hollowing-out induced by the FDI has been a great concern in Taiwan. The purpose of this paper is to establish a computable general equilibrium (CGE) model to investigate the impact of outward FDI by Taiwanese firms on its domestic economy. The efficiency wage theory is incorporated into the analytical framework. This paper first employs regression analysis to show that there exists severe wage rigidity in the labor market of Taiwan. Its simulation analysis then indicates that the outward FDI from Taiwan might reduce its income and employment to some extent. These results reveal that the outward FDI might hurt a distortion-ridden economy, which is consistent with the theoretical findings of Brecher and Choudhri (1987) and Basu (1998). However, it seems that the outward FDI could account for only a very small part of the recent increase in Taiwan's unemployment level.

Keywords:

• foreign direct investment
• efficiency wages
• unemployment
• computable general equilibrium model

JEL Classifications:

• F21
• J41
• C68

Notes

1. Taiwan is one of the earliest countries that introduced export-processing zones (EPZs) into their economies to attract direct foreign investment. Its first EPZ was established in 1966. See Chen et al. (2000) for a detailed discussion of Taiwan's inward foreign direct investment policies in the earlier period.

2. See Chen et al. (2006) and Lin et al. (2006) for recent evidence about the determinants of Taiwan's outward FDI.

3. See Chen et al. (2007), pp. 15–18.

4. Data are compiled from the website of Directorate-General of Budgeting, Accounting and Statistics (DGBAS), Executive Yuan, Republic of China.