Abstract: We develop a dynamic, general equilibrium model to understand how multinationals affect host countries through knowledge diffusion. Workers learn from their managers and knowledge diffusion takes place through worker mobility. We identify two forces that determine wages : the labour demand effect and the learning effect. The former tends to raise wages while the latter tends to reduce it. We show that in a model without learning, an integrated steady-state equilibrium in which incumbent host country managers operate alongside multinationals, can never be a Pareto improvement for the host country. In contrast, we present a novel mechanism through which a Pareto improvement occurs in the presence of learning dynamics. We study how integration affects the life time earnings of agents and the degree of inequality in the host country, as well as, analyze the pattern of multinational activity. In the quantitative section of the paper, we calibrate our model to fit key moments from the U.S. wage distribution and quantify gains from integration. Our estimates suggest that learning produces welfare gains that range from 2% for middle-income countries to 43% for the low-income countries.
Keywords: Multinationals, knowledge di¤usion, learning, welfare gains, worker mobility
JEL Classification: F23