An Analysis of Changes in Wealth Distribution upon the Entrance of Foreign Direct Investment Firms

This paper investigates the role of foreign direct investment (FDI) firms with respect to various economic aspects in developing countries, such as the determination of wealth distribution and the entry and exit of entrepreneurs. The model used in this paper is based on the theoretical framework developed in Matsuyama (2011). Unlike the original model focusing on a closed economy, this paper will introduce the arrival of FDI firms as a new actual foreign factor. It is shown that the FDI firms can possibly have various negative effects. More specifically, the following somewhat interesting results are obtained. First, the paper is the first to describe how the entrance of FDI firms can effect both wealth equality and inequality. This entrance can cause equality by acting as either a "big push" to push all the poorer members of society out of the poverty trap so that all domestic agents may become more equal with respect to wealth distribution and more free with respect to job selection. Conversely, it could lead to an "underdevelopment trap" whereby all domestic agents have no other choice than to work for FDI firms. On the other hand, the entrance of FDI firms may also cause inequality by widening the gap between rich and poor. The cost of starting a new business, the bequest motive and the world interest rate play critical roles in the determination of the effects of FDI-firm entry. Second, entry and exit of entrepreneurs is also analyzed under profitability and borrowing constraints and its relation to equality is also discussed.