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Competition for FDI with vintage investment and agglomeration advantages

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Author Info
Kai A. Konrad
Dan Kovenock

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Abstract

Countries compete for new FDI investment, whereas stocks of FDI generate agglomeration benefits and are potentially subject to extortionary taxation. We study the interaction between these aspects in a simple vintage capital framework with discrete time and an infinite horizon, focussing on Markov perfect equilibrium. We show that the equilibrium taxation destabilizes agglomeration advantages. The agglomeration advantage is valuable, but is exploited in the short run. The tax revenue in the equilibrium is substantial, and higher on "old" FDI than on "new" FDI, even though countries are not allowed to use discriminatory taxation. If countries can provide fiscal incentives for attracting new firms, this stabilizes existing agglomeration advantages, but may erode the fiscal revenue in the equilibrium.

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Paper provided by Purdue University, Department of Economics in its series Purdue University Economics Working Papers with number 1210.

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Length: 24 pages
Date of creation: Apr 2008
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Handle: RePEc:pur:prukra:1210

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Keywords: Dynamic tax competition vintage capital agglomeration foreign direct investment bidding for firms

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Find related papers by JEL classification:
F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
H71 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Taxation, Subsidies, and Revenue

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  8. Wildasin, David E., 2003. "Fiscal competition in space and time," Journal of Public Economics, Elsevier, vol. 87(11), pages 2571-2588, October. [Downloadable!] (restricted)
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  9. Holmes, Thomas J., 1999. "How Industries Migrate When Agglomeration Economies Are Important," Journal of Urban Economics, Elsevier, vol. 45(2), pages 240-263, March. [Downloadable!] (restricted)
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  13. Black, Dan A & Hoyt, William H, 1989. "Bidding for Firms," American Economic Review, American Economic Association, vol. 79(5), pages 1249-56, December. [Downloadable!] (restricted)
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