This paper investigates the role of foreign direct investment (FDI) in accounting for the long-term trend of capital flows under demographic changes. For this purpose, we incorporate horizontal FDI under the proximity-concentration trade-off into a two-country DSGE model and conduct a quantitative analysis using long-term Japanese data for capital flows since the 1960s. The quantitative analysis finds that the transition dynamics solely driven by demographic changes well account for the long-term trend of capital flows and that multinational firms’ endogenous decision on FDI in response to population aging is key to explaining the long-term trend.
Keywords: Capital flows; Demographic changes; Foreign direct investment (FDI)
Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.