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Competing for Foreign Direct Investment

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  • Barros, Pedro P
  • Cabral, Luis

Abstract

The paper analyzes "subsidy games" between countries in order to attract foreign direct investment (FDI) from a third country. The winner of this game results from the interaction of two factors, relative country size and employment gains from FDI: a large (or "central") country is more likely to attract FDI, and so is a country with high unemployment. The subsidy equilibrium is compared with two alternative solutions: zero subsidies and first-best subsidies. It is shown that total welfare may be greater under subsidy competition than under zero subsidies: the gains from efficient location implied by subsidy competition may more than outweigh the losses from higher subsidies. Moreover, departing from subsidy competition to zero subsidies or to first-best subsidies (without side payments) implies a gain to one country and a loss to the other. This suggests that it may be difficult to reach a consensus to move away from the status quo of subsidy competition. Copyright 2000 by Blackwell Publishing Ltd.

Suggested Citation

  • Barros, Pedro P & Cabral, Luis, 2000. "Competing for Foreign Direct Investment," Review of International Economics, Wiley Blackwell, vol. 8(2), pages 360-371, May.
  • Handle: RePEc:bla:reviec:v:8:y:2000:i:2:p:360-71
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