The Impact of a Natural Disaster on Foreign Direct Investment and Vertical Linkages

Abstract

How do multinational enterprises (MNEs) affect the host country's economy through their vertical industrial linkages when large natural disasters occur? To answer this question, we develop a simple theoretical framework and show the possibility of multiple equilibria: one where the host country is dominated by MNEs and the other where it is by local firms. When natural disasters seriously damage domestic capital and thus increase the cost of sourcing local inputs, the industrial configuration in the host country switches from domination by MNEs to domination by local firms. The replacement of MNEs with local firms can raise the welfare of the host country.

Keywords: Multinational enterprises (MNEs): Natural disasters: Capital destruction; Industrial linkages: Multiple equilibria

JEL Classification: F12: F23: Q54