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Subsidies for FDI: Implications from a Model with Heterogeneous Firms

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Author Info
Davin Chor () (School of Economics, Singapore Management University)

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Abstract

This paper analyzes the welfare e®ects of subsidies to attract multinational corporations, in a setting where ¯rms 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 costs of funding the subsidy program through a tax on labor income. This welfare gain stems from a selection e®ect, whereby the subsidy induces only the most productive exporters to switch to servicing the host's market via FDI. I further show that the welfare gain from a subsidy to variable costs is larger than from a subsidy to the ¯xed cost of conducting FDI, since a variable cost subsidy also raises the ine±ciently low output levels stemming from each ¯rm's mark-up pricing power.

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Publisher Info
Paper provided by Singapore Management University, School of Economics in its series Working Papers with number 04-2007.

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Length: 41 pages
Date of creation: Aug 2007
Date of revision:
Publication status: Published in SMU Economics and Statistics Working Paper Series
Handle: RePEc:siu:wpaper:04-2007

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Related research
Keywords: FDI subsidies; heterogeneous firms; fixed versus variable cost subsidies; import subsidies.;

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Find related papers by JEL classification:
F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies
F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
L23 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Organization of Production

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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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  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)
  6. Maurice Obstfeld & Kenneth Rogoff, 2001. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," NBER Chapters, in: NBER Macroeconomics Annual 2000, Volume 15, pages 339-412 National Bureau of Economic Research, Inc. [Downloadable!]
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  7. Fabio Ghironi & Marc J. Melitz, 2005. "International Trade and Macroeconomic Dynamics with Heterogeneous Firms," The Quarterly Journal of Economics, MIT Press, vol. 120(3), pages 865-915, August.
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  14. Marc J. Melitz, 2003. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," Econometrica, Econometric Society, vol. 71(6), pages 1695-1725, 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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  18. 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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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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