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Subsidies for FDI: Implications from a model with heterogeneous firms

  • Chor, Davin

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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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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