This paper examines the effects of Taiwan’s direct foreign investment (DFI) on the Taiwan economy. To achieve this aim, a dynamic econometric model of Taiwan with 29 industrial sectors was estimated and simulated. The model makes use of input-output relations in determining the sectoral outputs and prices. One of the features is the inclusion of DFI in both investment and export equations. DFI is itself explained by unit labor cost in US dollars.
Simulations for the period 1986-1991 indicate that increases in DFI stimulated exports but reduced domestic private fixed investment. However, the increases were harmful to the growth of the manufacturing industries which use labor intensively.
It is found that during the period about $76 (in Taiwan dollars) of domestic investment was displaced for every $100 of investment made abroad. Tripling the actual amount of DFI across industries during the entire period would result in an average growth rate about 0.3% lower than the actual average growth rate.
The effects of changing fixed domestic investment (private as well as public), the interest rate, the wage rate, and the exchange rate were also examined separately. The simulations show that the Taiwan economy is able to quickly recover within two years from external shocks and then resume its course of growth.
