Offshoring via vertical FDI in a long-run Kaleckian Model

Abstract

This paper develops a two-country Kaleckian model in which “Northern” firms invest a fixed fraction of total investment in foreign affiliates in the low-wage “South” in order to offshore the production of intermediate goods over time. On the back of this setup follows an analysis of the macroeconomic implications of offshoring in the short and long run. Offshoring through vertical FDI is found to lead to a falling wage share and a simultaneously falling price level and rising markup in the North, whereas the effect on equilibrium capacity utilization may be positive or negative. Regardless of the effect on capacity utilization and firm profitability, we can show that the structural change implied by offshoring leads to lower rates of capital accumulation and employment in the North in the short run. The long-run effects on Northern employment and growth, on the other hand, depend crucially on the long-run accumulation rate of the Northern-owned multinational firms and on whether wages in the North and the South endogenously converge. The model appears well suited to shed light on many real-world macroeconomic phenomena, such as rising FDI flows, falling wage shares, rising markups in an era of low inflation, hysteresis, and secular stagnation.