Openness, productivity and welfare with heterogeneous firms

Purpose The purpose of this paper is to theoretically examine the effects of outward FDI on domestic aggregate productivity and welfare. Design/methodology/approach This paper develops a North-South general equilibrium model in which firms' technology adoption and workers’ skill-technology matching are endogenous. Technologically heterogeneous firms in the North make explicit delocalization decisions to the South through FDI and heterogeneous workers endogenously sort into different technologies according to their respective comparative advantages. Findings This paper highlights how globalization-induced technology-upgrading mechanisms of firms and workers increase aggregate productivity and welfare, though at the cost of increased income inequalities. The model shows also that the same technological shock (favoring high-tech firms) leads to different results in closed and open economy: both technology up- and downgrading occur in closed economy, while technology upgrading prevails in open economy. Originality/value By modeling and exploring the technology-skill links in a North-South setting, this paper provides richer predictions on the implications of outward FDI. In particular, the model highlights that the initial openness degree of the economy matters: the more open the country initially, the more technology upgrading as globalization proceeds, leading to higher aggregate productivity and welfare gains.