Department of Policy and Planning Sciences
Discussion Paper Series

No.1371

Foreign Direct Investment and Wealth Distribution
Dynamics

byDuong Lam Anh TRAN

September 2020

UNIVERSITY OF TSUKUBA
Tsukuba, Ibaraki 305-8573
JAPANForeign Direct Investment and Wealth Distribution
Dynamics
Duong Lam Anh Tran∗
September 2020

This paper investigates the role of foreign direct investment (FDI) firms with respect
to the determination of domestic wealth distribution dynamics in the host country. Basedon the traditional dynasty framework, we derive a new version that introduces the entry of
FDI firms as an additional foreign factor to a closed economy. We find that the transitionof the domestic wealth distribution in response to the entry is not limited to monotonicallyincreasing or decreasing, but generates a rich set of engaging scenarios at the steady state,
namely the middle-income trap, the good equality, the bad equality, and the inequality.
Furthermore, we also identify factors that determine which scenario prevails, that is, thecost of starting a new business, the bequest motive, the world interest rate, and the laborproductivity of the host country.
Keywords: foreign direct investment, wealth distribution dynamics, job composition,
dynasty model
JEL Classification Number: D31, F21, O16∗

Correspondence address: Tran Lam Anh Duong, Faculty of Engineering, Information and Systems,
University of Tsukuba, Tennodai 1-1-1, Tsukuba, Ibaraki 305-8577, Japan. Email address: anhduongtl(at) sk.tsukuba.ac.jp1

1

Introduction

Over the last few decades, developing countries have witnessed a significant increase inforeign direct investment (FDI) inflows, making it the most important source of externalfinance for such countries (United Nations Conference on Trade and Development (UNCTAD)). Between 1990 and 2018, FDI inflows into developing countries increased by about
thirtyfold, as much as four times the world average, accounting for more than half ofglobal flows.1 Accompanying the surge in FDI inflows is an increasing concern about theadverse impacts of FDI on social equality.
Equality is mainly explored in two typical dimensions, namely wealth and income,which invoke different views of how economic resources are distributed in society. While
income is defined as a “flow” of resources in a specified period of time, wealth is known
as a “stock” of those resources, which is accumulated over a long period of time. The
key difference between the two is that wealth itself can generate income as it is a sourceof investment; thus, a higher inequality in wealth can widen that in income, or in otherwords, wealth inequality tends to be more pronounced than income inequality.2 Furthermore, although the two concepts are interrelated, it is clear from the perspective of
long-run dynamics that the stock of wealth is a more important factor than the annual
flow of income resulting from it (Baranzini, 1991). The goal of this paper is to develop aframework in which we examine the dynamic change in the domestic wealth distribution
in response to the entry of FDI firms.
Despite the importance of this issue, there are no studies of how foreign investment,
especially FDI, affects the wealth distribution. The closest studies examine such impacts
in terms of income, not wealth inequality. Although wealth inequalities appear to be
more important, the availability and reliability of income data have allowed inequalities
in income to be studied more closely (Brian, 2015). Our literature review, however,suggests that the results of the previous studies on income inequality, both theoreticaland empirical, are inconclusive. Empirical studies present inconsistent evidence on this
impact,3 while theoretical studies also yield mixed results through several mechanisms
1

Author’s calculations using the World Development Indicators database and World Investment Report 2019 of the UNCTAD.
2
Davies et al. (2009) find that income inequality is on average half of the size of wealth inequality inboth industrial and emerging economies. For example, most Gini coefficients for disposable income lie
in the range of about 0.35–0.45, whereas Gini coefficients for wealth typically fall in the range of about
0.65–0.80.
3Gopinath and Chen (2003), Choi (2006), Lee (2006), and Basu and Guariglia (2007) find, in crosssectional data across a large group of countries, that FDI promotes income inequality. In contrast, Borraz
and Lopez-Cordova (2007), Jensen and Rosas (2007), and Chintrakarn et al. (2012) both agree that FDI
results in less income inequality in Mexico and the US. On the contrary, Figini and Görg (2011), Herzer
and Nunnenkamp (2013), Franco and Gerussi (2013) draw conclusions on identifying the impact of FDI
on income inequality as a non-linear trend, while Lindert and Williamson (2003), Milanovı́c (2005), and2

(Feenstra & Hanson, 1996; Pandya, 2014).
In this context, Pandya (2014) makes an argument on the impact of FDI firms on
income inequality that is crucial to further develop dynamic models examining such an
impact on wealth inequality. Pandya (2014) argues that FDI could reduce income inequality because of the competition with domestic firms in the labor market. This competition
raises the incomes of domestic workers and drives down the income of domestic capitalists,
giving local capital owners incentive to use their influence on policymakers to restrict foreign ownership. Although the argument on the changes in domestic income is consistent
with some empirical observations (Aitken et al., 1996; Lipsey & Sjöholm, 2004; Hijzen
et al., 2013), they appear static only with no model specification. In order to examine
the impact of the entry of FDI firms on the distribution of both income and wealth,
we formalize and extend Pandya’s argument to a dynamic model by incorporating thismechanism into the traditional dynasty framework.
Dynasty framework is a series of previous models4 that progressively build on eachother to analyze the dynamics of household wealth distribution and development undercredit market imperfections. Based on the dynasty framework reviewed by Matsuyama(2011), we build a new version that includes the entry of FDI firms as an additional foreign
factor to a closed economy. In the traditional dynasty framework, changes in wealthdistribution are generated by the borrowing constraint which prevents poor individual
agents from accessing loans, thereby establishing a barrier between rich and poor agents.
From the perspective of the credit market, the borrowing constraint also plays a crucialrole in differentiating domestic firms, owned by local entrepreneurs, and FDI firms. Taking
advantage of this feature, we introduced the entry of FDI firms into the framework by
incorporating the differences in credit constraints between these two types of firms. In
particular, unlike the domestic firms, FDI firms can come from any country from the “restof the world,” and the “rest of the world” is assumed to be creditworthy such that their
credit constraint is not their major concern. Whenever profit remains positive, FDI firms
can always afford the setup costs and enter the domestic economy. The entry of FDI firms
then affects the overall structure of the labor market, followed by an endogenous change
in the domestic wealth distribution.
By providing country-specific conditions under which the entry of FDI firms alters the
distribution of domestic wealth and by examining such alternations dynamically, the paper
identifies four engaging scenarios for the entry of FDI firms. The first scenario is that, by
providing a “push” to move the poorer members of society out of a poverty trap, the entry
Sylwester (2005) find no evidence of a significant relationship between FDI and income inequality.
4
See Galor and Zeira (1993), Banerjee and Newman (1993), Aghion and Bolton (1997), and Matsuyama(2006).

3

of FDI firms yields good equality in wealth distribution and job selection among domestic
agents. In the second scenario, the entry of FDI firms worsens the financial condition of
all domestic entrepreneurs, leaving all local agents no choice other than to work as workers
for FDI firms, thus leading to bad equality. In the third scenario, by redistributing wealthto make the wealthiest agents, who survive the competition in the labor market with
FDI firms, better off, this entry widens the gap between the rich and poor, thus bringing
about greater inequality. Along with the discussion of these three scenarios, whereby thewealth distribution and the job composition are significantly changed, we also examine
another modest but feasible post-FDI scenario called the “middle-income trap.” In thismiddle-income trap scenario, the participation of FDI firms can make domestic workers
slightly better off, but they still cannot change their status as workers; thus, this entry
simply makes the economy more equal without any changes in job composition. In sum,the findings do not simply conclude that the effect of the FDI firms’ entry is monotonically
positive or negative, but describe it as a transition path from the initial entry of FDI firms
to the steady state, providing a rich set of scenarios. In addition, we identify four specificfactors that determine the effects of FDI firms’ entry, namely, the cost of starting a new
business, the bequest motive, the world interest rate, and the labor productivity in thehost country. In particular, when there is a lower cost of starting a new business, a greater
bequest to the next generation, a higher world interest rate, or higher labor productivity,
the entry of FDI firms is more likely to lead the economy of the host country toward a
new steady state where all domestic agents experience better equality in either wealthdistribution or both wealth distribution and job selection. Furthermore, we also provide
numerical examples to illustrate each scenario and their determinants.
The remainder of the paper is organized as follows. Section 2 presents the basic model.
Section 3 provides the theoretical analysis. Section 4 discusses the numerical examples.
Section 5 concludes.

2

The modelThis section presents a model that introduces the entry of FDI firms within a closed
economy as an additional foreign factor. The model is based on the dynasty frameworkpresented by Matsuyama (2011).
The basic assumptions of the model are as follows. Consider a country that consistsof an infinite number of generations. Each generation has a unit mass of identical agents
who live for only one period. The size of the population is assumed to be continuousand set to one. There is a single numeraire good that can be allocated to consumption,
inheritance, or investment. The country is assumed to be a small open economy where
4the interest rate, r, is determined exogenously depending on the current world rate, r ≥ 1.
Domestic agents
Agents in the economy are individuals who are assumed to be homogeneous in ability
but heterogeneous in initial wealth. Regarding initial wealth, at the beginning of period t, a representative Agentt inherits ht units of the numeraire good from his parent.
Then, based on the size of the inheritance received, he decides to either run a business as
an entrepreneur or work as a worker for another firm. This job selection allows for theendogenous entry and exit of entrepreneurs, which is an important channel of resource
allocation. At the end of the period, the agent derives utility by consuming ct and byleaving an inheritance ht+1 to the next generation. Thus, the utility function is
Ut = c1−βhβt+1 ,t(1)

where β is the bequest share.
If Agentt decides to become a worker, he can work in a domestic or an FDI firm andearn a wage of wt . At the beginning of period t, a worker does not need to spend moneyon either consumption or investment, so he lends all his idle inheritance, ht , at interest
rate r. Thus, at the end of period t, his wealth is wt + rht .
If Agentt decides to become an entrepreneur, he establishes a domestic firm and enjoys
its profit. Because agents in the economy are assumed to be homogeneous in ability, alldomestic firms share an identical production function such as:
Yt = φ(lt ),(2)

where φ0 > 0, φ00 < 0, φ(0) = 0, and lt is the number of workers working in this domestic
firm, lt ≤ 1. Labor is the sole production input. To start a firm, the entrepreneur must
pay a setup cost F , where F ≥ 0. At the beginning of period t, if he has more wealth than
the setup cost, he can lend the remainder, after paying F , at interest rate r. Thus, thewealth of the entrepreneur at the end of period t, can be derived as φ(lt )−wt lt +r(ht −F ),where wt lt is the labor cost. If we separate the part that varies with the number of workers,
φ(lt ) − wt lt , and denote it as π(lt ), the wealth of the entrepreneur can be rewritten asπ(lt ) + r(ht − F ). In order to maximize the profit, the entrepreneur determines the
optimal number of workers to recruit. His profit maximization condition takes the form
wt = φ0 (lt ), hence the optimum number of workers is lt = φ0−1 (wt ). Following that, we
obtain an intuitive interpretation that the optimum number of workers is a decreasing
function of wage, i.e., l0 (wt ) < 0.

5

Every entrepreneur is subject to two constraints, a profitability constraint and a borrowing constraint. First, in terms of the profitability constraint, an entrepreneur has no
incentive to invest unless his income is greater than that of a worker who receives thesame amount of inheritance. Thus, his profitability constraint is
π(lt ) + r(ht − F ) = π(l(wt )) + r(ht − F ) ≥ wt + rht .
This is equivalent to π(wt ) − wt ≥ rF. For wt to satisfy the profitability constraint,wt ≤ w ∗ ,(3)

where w∗ is a solution of the equation π(wt ) − wt = rF.5
Second, in terms of the borrowing constraint, we assume that an agent can only run abusiness if his initial wealth can cover the setup cost, F . This means that an agent cannot
access a loan to cover the shortage of the setup cost to start a business. This assumption
is consistent with the case of developing countries where the credit market has not beendeveloped yet, or in other words, the domestic credit market is still imperfect. Based on
this assumption, the borrowing constraint can be expressed as follows:ht ≥ F.

(4)

FDI firms
A new addition to the basic framework in Matsuyama (2011) is the introduction of FDI
firms to a closed economy. FDI firms in this model are defined as firms that are controlled
by foreign agents. In contrast to domestic firms in the host country, the most important
assumption relevant to FDI firms here, novel to this paper, is that they do not face any
borrowing constraints. FDI firms come from the “rest of the world,” and the “rest of theworld” is large and wealthy enough to ensure that as long as the profitability constraint
is satisfied, FDI firms can access global finance to make a loan of up to the amount of
the setup cost, F . Thus, there exist FDI firms that can afford to pay a setup cost toenter this economy. FDI firms enter the economy of the host country, hiring workers for5This equation always has a unique solution because the left-hand side is a decreasing function of
wt . This is true because the profit function, π(w), which is defined as φ(l(w)) − wl, is also a decreasing
function of w. We can proof this as follows. When we differentiate the profit function with respect to0
00
the wage, w, we have πw= φ0l lw
− (l + wlw). Under the profit maximization problem of domestic firm,00w = φl , the differentiation of profit can be rewritten as πw= −l, which is negative. Thus, profit function
is a decreasing function of the wage.

6

production, and at the end of the period, they repatriate the income earned back to theirhome countries.
Note that, in this paper, we do not focus on the potential effects of FDI firms such astechnological and human capital spillovers, or competition in domestic goods markets.6
Thus, we assume that FDI firms have the same production function as domestic firms,
i.e., Yt = φ(lt ).
Similar to domestic firms, FDI firms also face a profitability constraint. These firms
always invest if the profit can cover the setup cost. Thus, its profitability constraint is asfollows:
π(wt ) ≥ rF.
For wt to satisfy the profitability constraint,wt ≤ w∗∗ ,(5)

where w∗∗ is a solution of the equation π(wt ) = rF . It is obvious that if the profitability
constraint of a domestic firm is satisfied, that of FDI firms also holds, i.e., w∗∗ ≥ w∗ .7
Furthermore, one more realistic fact underlying FDI firms in this model is that such
firms face entry restrictions. Entry restrictions on FDI firms include not only formal restrictions on investment under the Investment Law, but also informal restrictions on an
ad hoc basis by regulatory authorities (Pandya, 2014). In this model, we integrate all
entry restrictions on FDI firms into an assumption that the ratio of the number of FDI
firms to the domestic population, θ, is given, where θ > 0.
Labor market
In the labor market, labor supply, defined as the participation in the labor force, is thenumber of people who cannot satisfy the borrowing constraint or people who fulfill such a
constraint but do not satisfy the profitability constraint to run a firm. When the wage islower than w∗ , under the profitability condition, all potential agents whose initial wealthcan cover the setup cost choose to become entrepreneurs. Thus, labor supply is precisely
equal to the rest of the population who cannot satisfy the borrowing constraint. However,when the wage is higher than w∗ , there will be no advantage in becoming entrepreneurs,
6

For details of such effects, see Markusen and Venables (1999), Fosfuri et al. (2001).
We prove the inequality w∗∗ ≥ w∗ here. First, w∗ is a solution of the equation π(wt ) − wt − rF = 0
at period t, that is, π(w∗ ) − w∗ − rF = 0. This is equivalent to π(w∗ ) − rF = w∗ > 0 because w∗ ispositive. Thus, when we solve the equation π(w) − rF = 0, the solution w∗∗ must be higher than w∗ ,because the left-hand side of this equation is a decreasing function of wage.
7

7

and labor supply equals the entire population. Labor supply is summarized such as:(
LSt =Gt (F ) wt ≤ w∗
1
wt > w ∗ ,where Gt (F ) denotes the fraction of the agents whose inheritance is less than the setup
cost, F , at period t.8 In fact, when wt equals w∗ , labor supply, LSt , can be either Gt (F )or 1. In the case that these variables equal, to avoid duplication, we take the initiative
to define labor supply as Gt (F ). A similar discussion on dealing with such an equality
applies to labor demand.
Labor demand is the number of workers that firms operating domestically need to
employ to maximize their profit. We examine two cases: the first, with no FDI firms, andthe second, with existing FDI firms. In the first case, where there is no FDI firm, when
the wage is lower than w∗ , the profitability constraint is satisfied. All agents who canafford the setup cost will start their businesses, taking advantage of a profit opportunity
because of low labor costs. Thus, in this case, labor demand is the total number of workers
hired by all domestic firms at such a wage. When the wage is higher than w∗ , no agent
can earn profit income higher than their wage income; thus, there are no domestic firms
and no labor demand. Labor demand in the case of no FDI firms is defined such as:((1 − Gt (F ))l(wt ) wt ≤ w∗
LD=t
0
wt > w ∗ ,where the term on the right-hand side of the first equation is a multiplication of thenumber of local firms, 1 − Gt (F ), and the number of workers hired by such a firm at wage
wt , l(wt ).
Next, we investigate the second case, the case of existing FDI firms. Similarly, becauseof the profitability constraints of both domestic and FDI firms, we consider three ranges ofwage which are lower than w∗ , between w∗ and w∗∗ , and higher than w∗∗ . First, with thewage lower than w∗ , both types of firms satisfy the profitability constraints; thus, labordemand is the total number of workers hired by both domestic and FDI firms at such low
wages. Second, when the wage ranges between w∗ and w∗∗ , only FDI firms satisfy the
profitability constraint; thus, labor demand is the total number of workers hired by only
FDI firms at such medium wages. Third, when the wage is higher than w∗∗ , no firm finds
it profitable enough to run the business; thus, labor demand remains at zero. Therefore,
labor demand in the case of existing FDI firms is as follows:8

Refer to borrowing constraint in equation (4).

8


∗

 (1 − Gt (F ))l(wt ) + θl(wt ) wt ≤ wLDθl(wt )w∗ < wt ≤ w∗∗
t =


0
wt > w∗∗ .
The first term on the right-hand side of the first equation indicates the total number ofworkers in domestic firms, while the second one shows the total number of workers whoare hired by FDI firms.
The market clears when labor demand equals labor supply, LSt = LDt . Under thismarket clearing condition, we solve for the equilibrium wage at period t, ŵt . All firms
operating domestically share this common wage.
Bequest rules
Based on the utility function in equation (1), to maximize utility, Agentt should leavean inheritance equal to a fraction, β, of his wealth at the end of period t. We consider
the bequest rule of an agent in two cases: the inheritance he receives from his parent islower or higher than the setup cost. When the inheritance the agent receives from his
parent is lower than the setup cost, he has no choice other than becoming a worker. Thus,
the inheritance he leaves for his child is the fraction β of his income earned as a worker.
A similar analysis applied to the remaining case yields that when an agent becomes anentrepreneur, at the end of period t, he leaves an inheritance for his child equal to thefraction β of his income earned as an entrepreneur. This bequest rule is shown as follows:(
ht+1 =3β(ŵt + rht )ht ≤ Fβ(π(ŵt ) + r(ht − F )) otherwise.

(6)

Theoretical analysis

We analyze the impact of the entry of FDI firms on wealth distribution and job composition dynamics in this section.

3.1

Wage movement and wealth dynamics

First, regarding wage movements, we recognize that while there is no change in labor
supply, labor demand increases because of the entry of FDI firms. This change in labordemand leads to an increase in the equilibrium wage; thus, we conclude that immediately
after the entry of FDI firms, the equilibrium wage increases. This conclusion is consistent
with the line of empirical research investigating the effect of FDI on the domestic wage
rate (Aitken et al., 1996; Lipsey & Sjöholm, 2004; Hijzen et al., 2013).
9

Next, because of the conclusion of the wage movement, we analyze the wealth dynamics
in response to the FDI firms’ entry. Based on the bequest rule derived in equation (6), we
illustrate the transition of domestic wealth, or in other words, the transition of inheritance,in Figure 1. The horizontal axis corresponds to the inheritance that Agentt receives from

Figure 1: Initial wealth dynamics without FDI firms

his parent, ht , and the vertical axis corresponds to the inheritance he leaves to his child,
ht+1 . To the left of F lies the line β(ŵt + rht ), called the “lower line,” showing thetransition of a worker’s wealth. The line β(π(ŵt ) + r(ht − F )) to the right of F , called
the “upper line,” indicates the transition of an entrepreneur’s wealth. Point A lies on the“lower line” at ht = F , while point B is located on the “upper line” at the same positionof ht . The equilibrium wage obtained in the labor market determines the position of these
two lines in each period. However, note that, because of the profitability constraint ofdomestic firms, the “upper line” is always vertically higher than the “lower line.”
At the steady state, the size of the inheritance that an agent leaves to his child is exactly equal to how much he receives from his parent, i.e., ht = ht+1 . Under the assumptionthat βr < 1, the steady state exists. The wealth of workers at the steady state, obtained
β ŵ
. On theat the intersection of the “lower line” and the 45-degree line, is hW = 1−βr
other hand, the steady-state wealth of entrepreneurs, which lies at the intersection of theŵ)−rF )“upper line” and the 45-degree line, is hE = β(π(1−βr, where ŵ is the wage at the steadystate. We name this steady state as the “poverty trap,” in which the population remains
polarized between workers and entrepreneurs. Workers are caught in a trap where theirinheritance never exceeds the setup cost to start a business without an external shock.
Besides, it is important to note that because every agent in the economy is homogeneous10

in ability, the graph of the wealth transition can be applied to any agent in the economy.9
Immediately FDI firms enter the economy, the equilibrium wage increases. This increase causes shifts in the wealth transition paths of all agents. The increase in theequilibrium wage raises income and, thus, increases the inheritance of the next generationof workers. However, the increase in the equilibrium wage decreases the profit of theentrepreneurs and, thus, reduces their income and subsequently lowers the inheritanceleft to their children. Therefore, the transition path of a worker’s wealth moves upwards,
while that of an entrepreneur’s wealth moves downwards.
With such shifts, the relative positions of points A and B change, altering the steadystate wealth of all the agents. In particular, upon the upward shift of the “lower line,”point A moves vertically upward. If point A moves to an allocation above the 45-degreeline, the intersection between this line and the “lower line” disappears. The same situation
happens to the intersection of the 45-degree line and the “upper line” when point B moves
to an allocation below the 45-degree line upon the downward shift of the “upper line.”
Therefore, depending on the new positions of points A and B, the entry of FDI firms
yields four different steady states for the economy: 1. Middle-income trap, 2. FDI-push,
3. FDI-dominance, and 4. Inequality. We describe these scenarios in the next section.

3.2

The steady states

In this section, we use figures to identify the characteristics of the four steady statesand explain the process of transition in each of them. Note that, in these figures, thedotted line corresponds to the period just before FDI firms enter, the dark-colored solidline presents the steady state, and the light-colored solid line, if any, shows an arbitrary
period during the transition process toward the steady state.
Scenario 1: Middle-income trap
In this scenario, equality is improved, but the job composition does not change upon theentry of FDI firms. Figure 2 illustrates how this happens. Graphically, when the new
points A and B still lie below and above the 45-degree line, respectively, a new steadystate exists, remaining the existence of both entrepreneurs and workers. At the newsteady state, agents whose initial wealth is smaller than the setup cost, F , can never
become entrepreneurs. In contrast, agents, whose initial wealth can cover such a cost,leave an amount of inheritance higher than F so that their descendants can still run abusiness. Hence, the job composition does not change. However, because of the increase
9Graphically, the condition for the existence and stability of the steady state is that points A and B
lie below and above the 45-degree line, respectively. We discuss this condition mathematically in Section
3.3.

11

Figure 2: Middle-income trapβ ŵ, increases, while thatin equilibrium wage, the steady-state wealth of workers, hW = 1−βr
β(π(ŵ)−rF)of entrepreneurs, hE =, falls. Workers become better off, while entrepreneurs
1−βrbecome worse off; thus, the entry of FDI firms in this scenario increases equality in theeconomy. We call this steady state the “middle-income trap.”

Scenario 2: FDI-push
Figure 3 illustrates this scenario. This scenario occurs when both points A and B move

Figure 3: FDI-push12

to allocations above the 45-degree line. In this scenario, workers can escape from thepoverty trap and become entrepreneurs. The transition process toward this steady stateis as follows. First, although the increase in the equilibrium wage upon the entry of FDI
firms does not affect the number of existing entrepreneurs even if there is a loss in profit, it
can raise the wealth of all workers so that some of the relatively rich ones become wealthy
enough to leave sufficient inheritance for their children to run a business. That is, thechildren of these rich workers become entrepreneurs, leading to a shrinkage of labor supply
and an increase in labor demand. As a result, the equilibrium wage increases further and,thus, more workers can become entrepreneurs. This process repeats itself continuously
until the income levels of workers and entrepreneurs are equivalent. The equality sign inthe profitability condition for domestic firms holds, leading to indifference with respect
to an agent’s job selection. Furthermore, the bequest rules of all agents are identical suchthat each agent leaves for his child the same fraction β of his income at the end of periodt; thus, the wealth levels of workers and entrepreneurs are also equivalent. The “lowerline” and “upper line” now merge into a single line lying between their original positions.
The wealth transition path for all agents that determines the steady state is shown as
the dark-colored solid line in Figure 3. In this scenario, every agent has the same levelof wealth, which is higher than, or at least equal to, the setup cost, i.e., hE = hW ≥ F .
Therefore, the entry of FDI firms in this scenario acts as a “push,” erasing the differencesin wealth distribution and job selection among domestic agents. The economy achieves
perfect equality; furthermore, it is a good equality. We call this scenario the “FDI-push.”
Mathematically, the wage at the steady state in this scenario satisfies the three following properties. First, the steady-state wage makes the “lower line” and the “upper line”
merge, yielding equality in the profitability constraint. That is, π(l(wt )) + r(ht − F ) =wt + rht , or we can rewrite this as π(wt ) − wt = rF. As we already solved this equation in
the setting of the profitability constraint, the equilibrium wage is w∗ . Second, the steadystate wage satisfies the labor market clearing condition under the case of existing FDI
firms, that is (1 − G∗ (F ))l(wt ) + θl(wt ) = G∗ (F ), where G∗ (F ) is the share of labor at the∗). Third, the wealth arisingsteady state. Following this, we find that G∗ (F ) = (1+θ)l(w
1+l(w∗ )from this steady-state wage must be higher than, or at least equal to the setup cost, F .
The steady-state wealth satisfies the condition ht+1 = ht = h∗ , or β(w∗ + rh∗ ) = h∗ ;βw∗βw∗
thus, h∗ = 1−βr(= hE = hW ). To satisfy the third condition, we must have 1−βr
≥ F , orF (1−βr)∗w ≥. Under these three conditions, the economy achieves perfect equality, andβ∗)∗)the shares of workers and entrepreneurs are (1+θ)l(w
and 1−θl(w, respectively.
1+l(w∗ )1+l(w∗ )Next, scenarios 3 and 4 occur when both points A and B move to allocations below
the 45-degree line upon the entry of FDI firms. We describe the transition process ap13

proaching this steady state as follows. First, although the increase in the equilibrium
wage in response to the entry of FDI firms does not affect the number of existing workers, it reduces the profit of entrepreneurs significantly such that this reduction makes all
entrepreneurs poorer. Some entrepreneurs cannot provide large inheritances that would
allow their children to run a business; thus, the next generation has no choice other thanbecoming workers, leading to an increase in labor supply and a decrease in labor demand.
This change in the labor market leads to an adverse reduction in the equilibrium wage.
Thus, in these scenarios, the equilibrium wage first increases and then declines becauseof the endogenous change in job composition. Graphically, the “lower line” and “upperline” initially move toward each other in response to the wage-increasing effect of theentry of FDI firms. However, soon afterward, they move back again. This reverse movement of the wealth transition paths of workers and entrepreneurs makes these scenarios
more complicated than the previous two. How far the two lines move away from eachother determines the properties of the new steady state. The formation of this movement
depends mainly on the initial wealth distribution of this economy at the time FDI firms
enter.

Scenario 3: FDI-dominanceIn this scenario, whereby all entrepreneurs in the economy are not wealthy enough toFigure 4: FDI-dominancewithstand the significant profit loss caused by the increase in wages in response to theentry of FDI firms, all of them are incapable of leaving a substantial inheritance. The
14

next generation cannot run businesses continuously and become workers. As a result,the labor supply eventually equals the entire population, and labor demand is now thepurview of FDI firms only. In particular, the large increase in labor supply, together withthe decrease in labor demand, leads to a decrease in equilibrium wage. No agent in an
economy, where the entire population works as workers, can change his status to be anentrepreneur; subsequently, all domestic agents work for FDI firms. The economy achieves
perfect equality, and the labor share equals one. The steady-state wage is the solutionof the labor market clearing condition where labor demand equals labor supply, that is
θl(w) = 1. The inheritance of all domestic agents at the steady state in this scenario islower than the setup cost, F . Thus, this scenario yields a bad equality, and we call it“FDI-dominance.” Figure 4 illustrates this situation. Every agent in this economy now
β ŵ.
shares the same steady-state wealth at hW = 1−βr
Scenario 4: Inequality
In this scenario, the increase in wage caused by the entry of FDI firms, followed by the
profit loss, increases the number of domestic entrepreneurs who become unable to leave
their children enough inheritance to run a business. However, this profit loss does notlast forever. The market exit of poor entrepreneurs leads to an increase in labor supply
and a decrease in labor demand, resulting in a wage reduction, thus easing the loss in
profits of the remaining entrepreneurs. Thus, if these relatively wealthy entrepreneurs
can survive until this loss ends, they can maintain large inheritances for their children
to run a business. At the new steady state, the number of workers increases, while thatof entrepreneurs decreases, but does not decrease to zero. Following that, the wealth ofworkers decreases, while that of the remaining entrepreneurs increases. The result thata small number of entrepreneurs own large amounts of wealth, while a large number ofworkers own small amounts of wealth, widens the gap between the wealth of workers andentrepreneurs, explaining the possible greater inequality in response to the entry of FDI
firms. Thus, we name this scenario “inequality.” Figure 5 shows such an example.

15

Figure 5: Inequality

The properties of the four scenarios described above are summarized in Table 1.
Table 1: Summary of the properties of the four scenarios (steady states)
Scenario
Equality status
Scenario 1: Middle-income trap Equal
Scenario 2: FDI-push
Perfectly equal (good)
Scenario 3: FDI-dominance
Perfectly equal (bad)Scenario 4: Inequality
UnequalWorker share
Unchanged(1+θ)l(w∗ )1+l(w∗ )1
Increase

Wage
Increase
Increase
Increase
Indeterminate

Note: w∗ is the equilibrium wage that satisfies the three properties discussed in the scenario 2.

There is a point worth noting here, that is, scenarios 2 and 4 are different from theothers in that they occur depending on the wealth diversity of workers and entrepreneurs,
respectively. Therefore, these two scenarios can only occur if FDI firms enter when theeconomy is not at the steady state in which workers’ wealth is identical, and so is entrepreneurs’ wealth. In contrast, other scenarios can happen regardless of the status of
the economy at the time FDI firms enter.10
10Theoretically, if FDI firms enter when the economy is at the steady state, it is possible for the
economy to converge to scenario 2. However, in this case, where all workers are identical in wealth andso are all entrepreneurs, it is not feasible for the sudden change in the job composition upon the entry of
FDI firms to immediately satisfy all three conditions discussed in scenario 2. Thus, we suppose that it
takes time for scenario 2 to adjust; thus, the diversity in the wealth of workers is necessary.

16

3.3

Conditions of the four scenarios

In this section, we examine the conditions under which these four scenarios may occur.
First, we discuss the conditions under which workers and entrepreneurs exist. The condition for the existence of workers or entrepreneurs or both depends on the comparative
positions of the “lower line” and “upper line” on the plane of the wealth transition path.
If the “lower line” and 45-degree line intersect, workers exist, and the intersection
determines their steady-state wealth, hW . This happens if and only if point A lies below
the 45-degree line, orβ(ŵt + rF ) ≤ F.
This is equivalent to ŵt ≤ ŵ1 , where ŵ1 ≡ F (1 − βr)/β. Thus, ŵ1 is the maximum wagethat ensures the existence of the workers. This is because if the wage is higher than ŵ1 ,workers become wealthy enough to leave their children an amount of inheritance that cancover the setup cost to run a business. As a result, under the profitability constraint, no
one becomes a worker.
On the other hand, if the “upper line” and 45-degree line intersect, entrepreneurs exist
and the intersection determines their steady-state wealth, hE . This happens if and only
if point B lies above the 45-degree line, orβ(π(ŵt ) + r(F − F )) ≥ F.
This can be rewritten as π(ŵt ) ≥ F/β; thus, the equation now is equivalent to ŵt ≤ ŵ2 ,where ŵ2 is the solution of equation π(ŵt ) = F/β. Thus, ŵ2 is the maximum wage that
ensures the existence of the entrepreneurs. This is because if the wage is higher than ŵ2 ,the loss in profit decreases the entrepreneur’s wealth, making them unable to leave enoughinheritance for their children to start a business; thus, there exist no entrepreneurs in thiseconomy.
Next, we discuss the conditions under which the four scenarios described Section 3.2
may occur. The first is scenario 1, the middle-income trap. In this scenario, there exist
both workers and entrepreneurs and, thus, points A and B lie below and above the 45degree line, respectively. The condition for this scenario is as follows:ŵt ≤ min (ŵ1 , ŵ2 ).
Intuitively, we know that when the equilibrium wage is low, workers are so poor that they
can never own a business, whereas entrepreneurs earn such a high profit that they canleave enough inheritance to their children to run a business. Therefore, the economy will17

contain both workers and entrepreneurs.11
The second is scenario 2, the FDI-push. In this scenario, workers can escape from thepoverty trap, while the existing entrepreneurs remain. The scenario occurs when both
points A and B lie above the 45-degree line, meaning that the condition guaranteeing theposition of these two points can lead to better equality. That isŵ1 < ŵt < ŵ2 .
Next, we consider scenarios 3 and 4, which are FDI-dominance and inequality, respectively. In these scenarios, both points A and B lie below the 45-degree line. The conditionof the equilibrium wage for this scenario is as follows:ŵ2 < ŵt < ŵ1 .
Scenario 1 differs from the other three scenarios in that the comparison between ŵ1
and ŵ2 does not affect the result. However, the specific conditions on this comparison for
scenarios 2, 3, and 4 are significantly different. The main difference between scenario 2
and the other two scenarios is that in scenario 2, ŵ1 < ŵ2 , while in scenarios 3 and 4, thereverse is true.
To compare ŵ1 and ŵ2 , first we note that the profit function is a decreasing function of
the equilibrium wage. Following that, the necessary condition for the FDI-push scenario(scenario 2), ŵ1 < ŵ2 , is satisfied if and only if profit calculated at ŵ1 is higher than that
calculated at ŵ2 , i.e., π(ŵ1 ) > π(ŵ2 ). This condition is rewritten as follows:F(1 − βr)π
β| {z }

!
>

F
.
β

(7)

ŵ1

This equation is applied to derive the following proposition.
Proposition. The FDI-dominance or inequality scenario (FDI-push scenario) cannot
exist if at least one of the conditions below holds:• The setup cost is sufficiently low (high).
• The bequest share is sufficiently high (low).
• The interest rate is sufficiently high (low).
• The host country’s labor productivity is sufficiently high (low).
11

This is also similar to the condition on the existence and stability of the steady state prior to theentry of FDI firms discussed in Section 3.1.

18

Mathematically, when F is low, or β and r are high, equation (7) holds, making ŵ1
more likely to be smaller than ŵ2 ; thus, the FDI-dominance or inequality scenario cannot
occur. Intuitively, first, if the cost required to start a firm is low, it is easier for agentswith moderate inheritance to become entrepreneurs, especially agents whose inheritances
are very close to F . Once those agents become entrepreneurs, the structure of the labormarket changes with demand increasing and supply decreasing, raising the equilibrium
wage, making it easier for others to become entrepreneurs as well. The role of the setup
cost leads to a policy implication. The setup cost used in this chapter is the expense
associated with the entire process of establishing a new firm. Part of this cost is related
to government policies, both tangible (i.e., legal and professional fees, license, etc.) andintangible (i.e., registration time, administration, corruption, etc.). Therefore, together
with accepting FDI firms, if the government imposes policies that ease the environment
for firm establishment, the economy can achieve better equality. Second, if the bequest
share of the agent is high, or in other words, he is altruistic, the inheritance increases.
Third, when the interest rate is high, although none of the agents can borrow, returns
to lenders increase because of the high capital gains. In this case, the wealth of workers
increases and, thus, the inheritance increases as well. Finally, if the host country’s laborproductivity is high, the wealth of all domestic agents increases. It is obvious that thehigher the wealth is, the greater the inheritance becomes, and more workers can become
entrepreneurs. Therefore, the economy cannot converge to scenario 3 or 4. Only scenario
1 or 2 occurs, leading to better equality in either wealth distribution as in scenario 1 orboth wealth distribution and job selection as in scenario 2.

4

Numerical examples

The goal of this section is to illustrate quantitatively the four scenarios discussed in Section
3.2 by introducing a numerical simulation analysis using assumed parameter values.

4.1

Specific functions and parameter settings

First, the model is approximated by a discrete number of domestic agents in order to be
tractable for the simulation. Here, we suppose the size of the population is L.
Second, functions used in the model need to be explicitly specified. The production
function is assumed to have the following form:
Yt = φ(lt ) = Altα ,19where A is an index of technology and α is the output elasticity with respect to labor.
Third, inheritance is different for each agent. The initial wealth distribution is assumed
to take the Pareto distribution form. Thus, the initial inheritance of agent i is
− hminhi0 = (hmax
0 )
0

 k
i
, i = 1 · · · L,
L

(8)

where k is the parameter of the Pareto distribution, and hmax
and hminare the initial
00
wealth of the wealthiest and poorest agents, respectively.
Finally, in the benchmark scenario, all the parameters in the model are set as in Table
2.
Table 2: Some specific parameters
Parameter
α
β
r
F
A
hmax
0
hmin
0
θ
k
L

Value
0.5
0.5
1.1
0.8
1
3F
0.01F
0.01
20
10,000Note
Output elasticity with respect to labor
Bequest share
World interest rate
Setup costIndex of technology
Initial wealth of the wealthiest agent
Initial wealth of the poorest agent
Share of FDI firms over population of the host country
Parameter of Pareto distribution
Population size

With this setting, about 6% of the population in the initial distribution can become
entrepreneurs.

4.2

Findings

This section discusses the numerical examples. In the theoretical analysis on the four
scenarios in Section 3.2, we mentioned the dependence of scenarios 2 and 4 on the wealth
diversity of workers and entrepreneurs, respectively. Thus, for scenarios 2 and 4, FDI
firms are assumed to enter when the economy is not at a steady state. In contrast,
scenarios 1 and 3 can occur regardless of the status of the economy at the time FDI firms
enter. Therefore, in order to clarify the difference among the four scenarios, we simulate
all of them with regard to the case where FDI firms enter when the economy is not at its
steady state.12 When the economy is not at its steady state, we assume its initial wealth12

To check the robustness, the simulation results of scenarios 1 and 3 for the case where FDI firms
enter when the economy is at its steady state are shown in the Appendix.

20

distribution at the time FDI firms enter to be defined as in equation (8). Here, amongfour determinants of the impact of FDI firms mentioned in the Proposition, we adjust
bequest share, β, to demonstrate the four scenarios quantitatively. The simulation results
are shown in Figures 6 to 9.
Each figure has four panels labelled a to d. In panels a, b, and c, the horizontal axes
indicate time (period). The solid lines show the transition paths of three factors, i.e.,
wage, worker share, and Gini coefficient, in response to the entry of FDI firms at period
1. To compare with the case of no FDI firm, we let the dotted lines illustrate the steadystate level of those three factors when there is no FDI firm entering the economy. Notethat such steady-state levels do not correspond to the time measures on the horizontal
axis. Panel d shows the steady-state wealth of all domestic agents in both cases, withand without FDI firms. All agents in the economy are ordered from the poorest to thewealthiest along the horizontal axes. The solid line shows the steady-state wealth of thecase where FDI firms enter, while the dotted line illustrates that of the case with no FDI
firm.

Scenario 1: Middle-income trap (benchmark)This benchmark scenario corresponds to scenario 1, the “middle-income trap.” The simulation results are described in Figure 6 with benchmark parameters shown in Table 2.
Figure 6a shows the wage schedule. As the solid line lies above the dotted line, thewage is found to be higher in the case of FDI firms compared with the case of no FDI firm.
Furthermore, the wage remains unchanged for the entire period, indicating that after FDI
firms enter the host country in period 1, there is no flow from the pool of workers into thepool of entrepreneurs or vice versa. When there is no change in the composition of labor
supply and demand, the wage takes a constant value, which is equal to the steady-statevalue.
Figure 6b shows no change in the worker share compared with that at the steady stateof the case with no FDI firm. The worker share is 94.6%.
Figure 6d shows the steady-state wealth distribution with regard to two cases, withand without FDI firms. We can observe the difference in agents’ wealth and the indifference in the job composition. Because of the increase in wages, workers become richer,while entrepreneurs become poorer upon the entry of FDI firms. The wealth of domestic
workers and entrepreneurs at the steady state is 9.3% higher and 14.1% lower, respectively,
compared with the case of no FDI firms.
Finally, Figure 6c shows a lower Gini coefficient at the steady state in the case of
FDI firms compared with the case of no FDI firms, representing greater equality. Thus,

21

Figure 6: Middle-income trap (benchmark) scenario

in this economy, the entry of FDI firms, followed by better-off workers and worse-off
entrepreneurs, brings an improvement in equality.

Scenario 2: FDI-push
Figure 7 shows the simulation results of scenario 2, named “FDI-push,” with the bequest
share increasing from 0.5 (benchmark scenario) to 0.8.
As the equilibrium wage rises soon after the entry of FDI firms and the bequest shareis high enough, the inheritance that workers leave to the next generation increases significantly so that their children can afford the setup cost. Because of the profitability
condition, when the inheritance is larger than the setup cost, agents would rather become
entrepreneurs than workers. Thus, agents not bound by the borrowing constraint pay
the setup cost to run their businesses. The number of entrepreneurs increases, while thenumber of workers decreases, leading to an overall increase in the wage. The continuous
increase of the equilibrium wage is shown in Figure 7a, while the decrease in worker shareis illustrated in Figure 7b. The increase in wage, the decrease in firm profit, and the22Figure 7: FDI-push scenariotransition of agents from workers to entrepreneurs continue until the economy approaches
the steady state where the income and the wealth of the workers and the entrepreneurs
become equal. Time to converge to the steady state is 14 periods. From then on, individuals are indifferent between becoming a worker or an entrepreneur, which results in aperfect equality of wealth. This equality is indicated as a reduction of the Gini coefficient
to zero in Figure 7c. Figure 7d shows the wealth at the steady state of all agents inthe economy in both cases, with and without FDI firms. The steady-state wealth of all
domestic agents after the entry of FDI firms is equal, and the size of the inheritance islarger than the setup cost. The result shows that with a high bequest share, the economy
can achieve better equality as shown in the Proposition.

Scenario 3: FDI-dominance
Figure 8 shows the simulation results of scenario 3, named “FDI-dominance,” with thebequest share decreasing from 0.5 (benchmark scenario) to 0.21.
Immediately after the entry of FDI firms, the equilibrium wage is relatively high in

23

Figure 8: FDI-dominance scenario

the first period. However, because of the high equilibrium wage, entrepreneurs’ profits
fall. In this scenario, the decrease in profit along with the lower bequest share makes thechildren of all entrepreneurs poorer so that they are eventually unable to pay the setup
cost to run their businesses, or in other words, they have no choice other than working as
workers in FDI firms. As a result, the worker share becomes one, as shown in Figure 8b.
As every agent in this economy becomes a worker, the abundance of labor supply leads
to a decline in wage. Figure 8a shows a reduction in wages from a high level at period
1. Wages at the steady state drop to less than half of what they were in the period rightafter FDI firms entered the economy but are still higher than the case of no FDI firm.
Thanks to this, workers in this scenario are still better off as shown in Figure 8d.
As the economy achieves perfect equality, Figure 8c shows the zero-convergence of
the Gini coefficient. Figure 8d also confirms the perfect equality where the steady-state
wealth of all agents in the economy is the same. However, this is an equality in which
every agent is poor; no one can become an entrepreneur because the steady-state wealthis substantially lower than the setup cost. Thus, with a lower bequest share comparedwith the benchmark, this scenario shows bad equality named “FDI-dominance.”
24

Scenario 4: Inequality
Figure 9 shows the simulation results of scenario 4, named “inequality,” with the bequest
share decreasing from 0.5 (benchmark scenario) to 0.3. Besides, as discussed in Section
3.2, scenario 4 occurs depending on the wealth diversity of the domestic entrepreneur;thus, to create a larger diversity in the wealth of entrepreneurs, hmax
is supposed to be0
quadruple, 4F , instead of triple the setup cost as in the benchmark case in Table 2.

Figure 9: Inequality scenario

As the equilibrium wage increases soon after the entry of FDI, some poor entrepreneurs,
who face reductions in profit, do not have much wealth to leave to the next generation sotheir children cannot run a business. The exit of poor entrepreneurs leads to a decreasein labor demand and an increase in labor supply, followed by a reduction in wage. The
steady-state wage is 10.6% lower than that in the case of no FDI firm as shown in Figure
9a. The increase in labor supply is illustrated in Figure 9b. However, although some poor
entrepreneurs’ children have no choice other than becoming workers, the children of thewealthiest families still inherit enough to afford the setup cost, paying F to run a business. Therefore, the worker share in Figure 9b converges to 98.7% but not 100% as in the
scenario of FDI-dominance. The wealth at the steady state of these wealthy entrepreneurs
25and other workers is illustrated in Figure 9d. Compared with the case of no FDI firm,
the steady-state wealth of workers after the entry of FDI firms decreases by 10.6% whilethat of entrepreneurs increases by 17.2%. In the economy, 98.7% of agents share thesame wealth; thus, the Gini coefficient in Figure 9c still shows a downward trend as thewealth distribution becomes more equal. However, the fact that entrepreneurs, consistingof only 1.3% of the population, hold nearly 30% of the wealth of the whole country, showsthat inequality becomes more serious in this scenario. The comparison is with regard to
scenario 1, where an approximately equal percentage of wealth is held by 5.4% of the
population.

5

Conclusion

The purpose of this paper is to analyze the changes in domestic wealth distribution andjob composition in response to the entry of FDI firms. We develop a model of dynamic
wealth distribution in the presence of an imperfect capital market. To our knowledge,
instead of echoing previous studies that mainly focus on the static income inequality
among workers, this is the first dynamic model that investigates the impact of the entryof FDI firms on domestic wealth distribution. The findings not only conclude that theeffect of the entry is monotonically positive or negative but describe it as a transition pathfrom the initial entry of FDI firms to the steady state, providing a rich set of scenarios.
More specifically, the model is based on the traditional dynasty framework presented
by Matsuyama (2011). The main assumption regarding FDI firms introduced into thisframework is that unlike the domestic firms, these firms are sufficiently creditworthy thatcredit constraint is not their primary concern. We use the model to examine the transitionof wealth and labor corresponding to the entry of FDI firms. Through this theoreticalanalysis, the paper describes this transition with four engaging scenarios. First, theparticipation of FDI firms can make the economy more equal without any changes in job
composition by having domestic workers slightly better off, but still unable to change
their status as workers. We call this scenario “middle-income trap.” Second, the entry of
FDI firms can produce a good equality by providing an “FDI-push” to move workers outof a poverty trap so that all domestic agents become equal with respect to wealth andjob selection. Third, FDI firms may cause the economy to fall into an “FDI-dominance,”
leading to a bad equality whereby all domestic agents have no choice other than to work
for FDI firms at a low wage. Fourth, the entry can also widen the gap between therich and the poor, causing inequality by redistributing domestic wealth to make thewealthiest agents better off if they can survive the competition with FDI firms. We also
identified four factors affecting the impact of FDI firms on the economy, namely, setup
26

costs, bequest motives, world interest rates, and the host country’s labor productivity.
More specifically, a lower cost in starting a new business, a more altruistic population,a higher world interest rate, and higher labor productivity of the host country could
promote better domestic wealth equality. This result suggests the policy implication
that, together with accepting FDI firms, if the government imposes policies that ease
the environment for firm-establishment or enhance labor productivity, the economy canobtain better equality. Furthermore, we also provide numerical examples to illustrateeach scenario and their determinants.

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Appendix. Some extra simulation results
In the main text, FDI firms are assumed to enter when the economy is not at a steadystate. To check the robustness of the results, in this Appendix, we assume that FDI
firms enter when the economy is at its steady state, or in other words, this steady state
occurs before FDI firms enter the economy. As discussed in Section 3.2, in this situation,
only scenarios 1 and 3 occur because of the independence of these two scenarios on wealth
diversity. We simulate these two scenarios with the same parameters and function settings
as in Section 4.1. The only modification here is that when FDI firms enter, the economy
already converged to a steady state from the initial wealth distribution shown in equation(8). At this steady state, all the workers are identical in terms of wealth, and so are theentrepreneurs as shown in Figure 1. Following that, if the increase in the equilibrium
wage caused by the entry of FDI firms forces a worker or an entrepreneur to change theirjob, other workers and entrepreneurs do the same.
Figure 10 shows the simulation results for scenario 1 with all benchmark parameters. After the increase in wage upon entry of FDI firms, workers are better off andentrepreneurs are worse off, while the job composition remains unchanged, leading to abetter equality.
Figure 11 illustrates scenario 3 with the change in the bequest share from 0.5 (benchmark scenario) to 0.25. Because of the increase in wages upon the entry of FDI firms,
domestic entrepreneurs start facing profit losses. They put up with this loss until thefifth period, then become so poor that they are unable to leave their children enough inheritance to run a business. Thus, all entrepreneurs have no choice other than becoming
workers working for FDI firms, sharing the same wealth. The economy achieves perfectequality as the Gini index decreases to zero from the ninth period. Besides, following
the increase in labor supply and the decline in labor demand, wages drop below thesteady-state level prior to the entry of FDI firms.
We find that the simulation results are almost the same as those in the main text.
The only difference is that in this case, the changes in worker share and Gini coefficient
in response to the entry of FDI firms, as shown in panels b and c, both start from the oldsteady-state level prior to such entry. This is natural because the economy is assumed to
be at the steady state when FDI firms enter. The other results remain almost unchanged,
meaning that all the features of scenarios 1 and 3 discussed in the theoretical analysis canbe demonstrated quantitatively regardless of the status of the economy at the time FDI
firms enter.

29

Figure 10: Scenario 1 in the case where FDI firms enter when the economy is at the steady
state

30

Figure 11: Scenario 3 in the case where FDI firms enter when the economy is at the steadystate

31