The Effects of Globalization on the Elasticity of Labor Demand and Employment

This paper examines the effect of globalization accelerated by an expansion in trade and foreign direct investment (FDI) on the national labor demand under an open economy with underemployment. We find that the higher the elasticity of substitution, the flatter the tangent slope of the labor demand curve under a trade economy (without FDI). If the wage level at home is much higher than that in a foreign country, an increase in the elasticity of substitution decreases domestic employment. The beginning of FDI with international production relocation makes the tangent slope of the home labor demand curve flatter than that under a trade economy. If the home wage falls within the high (low) range, FDI decreases (increases) home employment. This result implies that, in agreement with the conventional wisdom, FDI does not necessarily lead to the hollowing out of employment in a high-wage country.