On Multinational Firms, Diffusion of Skills and Development

I study the implications for the development of a country hosting of multinational firms. The paper argues that despite the negative impact on existing local firms, the presence of foreign firms induce the emergence of a new sector of domestic firms and that in the long term, the country to converge to the income level of the developed (source) country. I study the equilibria of close and open economies and show that for a set of initial conditions, the only possibility for a country to develop is to open to multinational firms. Moreover, the model shows that openness to multinational firms eliminates the possibility that a country unilaterally falls back into underdevelopment. The paper also shows that entry of foreign firms may excessively impair the accumulation of productivity of existing domestic firms.