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Subsidies for FDI: Implications from a model with heterogeneous firms

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Author Info
Chor, Davin

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Abstract

This paper analyzes the welfare effects of subsidies to attract multinational corporations when firms are heterogeneous in their productivity levels. I show that the use of a small subsidy raises welfare in the FDI host country, with the consumption gains from attracting more multinationals exceeding the direct cost of funding the subsidy program through a tax on labor income. This welfare gain stems from a selection effect, whereby the subsidy induces only the most productive exporters to switch to servicing the host's market via FDI. I further show that for the same total subsidy bill, a subsidy to variable costs delivers a larger welfare gain than a subsidy to the fixed cost of conducting FDI, since a variable cost subsidy also raises the inefficiently low output levels stemming from each firm's markup pricing power.

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Publisher Info
Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 78 (2009)
Issue (Month): 1 (June)
Pages: 113-125
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Handle: RePEc:eee:inecon:v:78:y:2009:i:1:p:113-125

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Web page: http://www.elsevier.com/locate/inca/505552

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Keywords: FDI subsidies Heterogeneous firms Fixed versus variable cost subsidies Import subsidies;

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References listed on IDEAS
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  3. Haufler, Andreas & Wooton, Ian, 1999. "Country size and tax competition for foreign direct investment," Journal of Public Economics, Elsevier, vol. 71(1), pages 121-139, January. [Downloadable!] (restricted)
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    Other versions:
  5. Eckhard Janeba, 2002. "Attracting Fdi in a Politically Risky World," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 43(4), pages 1127-1155, November. [Downloadable!] (restricted)
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  15. Devereux, Michael P. & Griffith, Rachel, 1998. "Taxes and the location of production: evidence from a panel of US multinationals," Journal of Public Economics, Elsevier, vol. 68(3), pages 335-367, June. [Downloadable!] (restricted)
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  16. Pennings, Enrico, 2005. "How to maximize domestic benefits from foreign investments: the effect of irreversibility and uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 29(5), pages 873-889, May. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Matthew T Cole & Ronald B Davies, 2009. "Optimal Tariffs, Tariff Jumping, and Heterogeneous Firms," Working Papers 200919, School Of Economics, University College Dublin. [Downloadable!]
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