Volatility, employment and the patterns of FDI in emerging markets

The purpose of this paper is to explore the implications of the deepening presence of multinationals in emerging markets on the cost of macroeconomic volatility there. We find that macroeconomic volatility has a potentially large impact on employment and investment decisions of multinationals producing intermediate inputs in developing countries. This is the case even for risk neutral multinationals, as their profit function is non-linear due to price and productivity effects. For industries with costly capacity, the multinationals would tend to invest in the more stable emerging market/s. Higher volatility of productivity shocks in an emerging market producing the intermediate inputs reduces the multinationals' expected profits. High enough instability in such a market would induce the multinationals to diversify intermediate input production, investing in several emerging markets. This effect is stronger in lower margin industries. We identify circumstances where this diversification is costly to emerging markets. Such a diversification increases the responsiveness of the multinationals' employment in each country to productivity shocks, channeling the average employment from the more to the less volatile location, and reducing the multinationals' total expected employment in emerging markets. (C) 2003 Published by Elsevier B.V.