Foreign Direct Investment into Open and Closed Cities

Publication Date01 May 2015
AuthorKristof Dascher
Kristof Dascher*
This article argues that the more open a city is to immigration, the more likely
it is to welcome and hence also receive foreign direct investment (FDI). If
immigration is allowed to complement the inflow of foreign capital, urban rent
rises by more. This extra rise in rent aids in appeasing owners of capital specific
to local traditional industries who else become worse off as FDI flows in. The
article’s model may help give a simple alternative explanation of why urban cen-
ters such as Hong Kong, Singapore, Dublin or many cities on China’s Eastern
coast have received so much more FDI per capita. These cities could draw on a
nearby pool of extra labor that by driving rents up and keeping wages down
may have been decisive in the political struggle over whether to let foreign direct
investors in.
Foreign direct investment (FDI) can often be traced back to the characteris-
tics of the investor, the host country, or the home country (Blonigen and
Piger, 2011). Enjoying a coincident inflow of labor is, to be sure, not commonly
considered one of these determinants of FDI. Yet such an inflow is at the
heart of the World Bank’s explanation of why Hong Kong and Singapore
became those eminent recipients of FDI (World Bank, 1993). Employment
with foreign direct investors attracted an influx of workers from the two cities’
respective hinterlands. This immigration did not drive out indigenous house-
holds, who had been provided with their own housing. Instead this immigra-
tion drove up urban rent, making indigenous landlords better off.
Capitalization of FDI-induced immigration into land values may be why
indigenous voters embraced, rather than opposed, FDI in the first place.
Attracting FDI, so this political economy narrative suggests, is easier for
cities that enjoy an abundance of extra labor close by, and whose indigenous
residents own their dwellings themselves. This article explores this idea
further, in a model that combines standard characteristics of a small trading
and factor importing economy with the rivalry for land typical of the urban
*Regensburg University
Scottish Journal of Political Economy, DOI: 10.1111/sjpe.12070, Vol. 62, No. 2, May 2015
©2015 Scottish Economic Society.
society. The modeling synthesis we obtain reveals a number of price changes
that may characterize an FDI recipient city. Not just may wages rise, and
may returns to capital specific to local traditional industries fall as FDI flows
in. Urban rent might rise, too. It is this variety of price changes and the corre-
sponding ambiguities in household income changes that must inevitably
impact on political interests and hence government’s decision on whether or
not to bid for FDI.
Despite these ambiguities in detail, we are able to obtain an overall result
that seems unambiguous and straightforward enough. We will show that a
city is the likelier to welcome (and hence receive) FDI in the first place the
more extra immigrants it can count on once FDI has started flowing in. Bor-
rowing a little terminology from urban economics, an open city is one that is
surrounded by a worker supply which is perfectly elastic with respect to the
city’s living conditions, whereas a closed city is one that can never hope to
pull in any extra labor. So this article simply finds that an open city is more
likely to attract FDI than a closed city is. We will also show that in some cir-
cumstances this labor mobility distinction can be sharpened further still. Then
a closed city not just attracts less FDI than an open city does but even fails
to attract FDI altogether.
Our distinction between open and closed cities ultimately derives from the
pivotal role of urban land ownership and rent. We will see that those FDI-
induced changes in wages and capital rentals are independent of just how
open the city is. But the same will not be true of the implied changes in the
urban rent. Urban rent always rises by more if the city is open, reflecting
immigrants’ extra pressure on the market for urban land. It is precisely this
increase in rental incomes that may help offset those losses certain to arise in
the city’s more traditional industries (as in Corden and Neary, 1982). In an
open city, the class of indigenous land-owning capitalists may then actually
still be better off. In the closed city, in contrast, owning land provides no con-
solation for local traditional industries’ decline. Put differently, having reason
to hope for land value capitalization may be a driver of providing local public
inputs specific to FDI. This article might thus also be seen as an addition to
the household mobility (i.e. Tiebout-) literature on local public goods.
While our focus is on the political economy of FDI, our auxiliary results
may be of interest, too. In an open city, providing a local public input to FDI
not just fuels both FDI and immigration by itself. Also, in this study’s model
these inflows reinforce each other. Mutual reinforcement may well have been
part of the spectacular growth observed in Hong Kong and Singapore, where
several million immigrants surely not just followed foreign investors but in
turn also attracted them. Mutual reinforcement may also have been underly-
ing Chinese coastal cities’ success in attracting FDI (Madariaga and Poncet,
2007; Zheng et al., 2010). There the recent surge in FDI coincided with the
partial dismantling of the hukou system which before placed tight restrictions
on hinterland emigration. To give a European example, Dublin seems another
open city with a strong history of simultaneous inflows of FDI and workers
(Barry and Hannan, 1995; Barry, 2002; Honohan and Walsh, 2002).
Scottish Journal of Political Economy
©2015 Scottish Economic Society

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