Trade Integration, Welfare, and Horizontal Multinationals: A three-country model

In this paper, we construct a three-country model with national and multinational (multi-plant) firms, in which oligopolistic firms in each country export their goods to other countries. We investigate the effects of trade liberalization between two countries on the third country. When the fixed costs of foreign direct investment (FDI) are sufficiently large, the firm does not conduct FDI, and trade liberalization always reduces the welfare level of the third country. When the fixed costs of FDI are small, trade liberalization may improve the welfare level of the third country. In addition, we observe cases under which trade liberalization between two of the countries improves the welfare of all three countries. In those cases, the two countries have incentives to join a free trade agreement (FTA), while the third country has no incentive to do so.