Outward Direct Investment, Reverse Import, and Domestic Production : Evidence from Taiwanese Manufacturing Firms

Abstract

The current wave of globalization has raised serious concerns of many countries whether increasing outward foreign direct investment (FDI) will cause the hollowing out of their domestic economies. In this paper we use Taiwan as a case study to examine the interrelationship between foreign production and domestic production with a special focus on the role of reverse imports. We show that without considering reverse imports properly, the empirical results may be biased or even reversed. By endogenizing a firm’s decisions on reverse imports as well as on domestic and foreign production, we show that foreign production has no significant substitution e#ect on domestic production, but it may have a significantly negative e#ect on domestic production indirectly through variables related to firms’ characteristics, such as firm size, the export ratio, labor intensity, the destination of the FDI, and the a$liate’s rate of return relative to its parent. Demand variables (e.g., market size, GDP per capita) and cost conditions (e.g., relative wages) do not play a significant role in a#ecting a multinational firm’s domestic production.