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Foreign Direct Investment and Customs Union: Incentives for Multilateral Tariff Cooperation over Free Trade

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  • Yildiz, Halis Murat

Abstract

We examine the implications of a customs union (CU) on the pattern of tariffs, welfare and the prospects for free trade when the nonmember firm has an incentive to engage in foreign direct investment (FDI). First we show that upon the formation of a bilateral CU, the non-member firm has greater incentives to engage in FDI. However, when FDI becomes a feasible entry option for the nonmember firm under a CU, member countries have incentives to strategically induce export over FDI by lowering their joint external tariff. When fixed set-up cost of FDI is sufficiently low, this tariff falls below Kemp-Wan tariff and CU leads to a Pareto improvement relative to no agreement. Moreover, using an infinite repetition of the one-shot tariff game under a CU, we show that FDI incentive of the nonmember firm makes the member countries (nonmember country) more (less) willing to cooperate multilaterally over free trade.

Suggested Citation

  • Yildiz, Halis Murat, 2010. "Foreign Direct Investment and Customs Union: Incentives for Multilateral Tariff Cooperation over Free Trade," MPRA Paper 22346, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:22346
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    Cited by:

    1. Pritish K. Sahu, 2016. "Malaysia's Domestic Value Added Export: The Role of Governance and Strategic Policy Reforms," International Journal of Economics and Financial Issues, Econjournals, vol. 6(4), pages 1578-1584.

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    More about this item

    Keywords

    Customs Union; Foreign Direct Investment; Multilateral Tariff Cooperation.;
    All these keywords.

    JEL classification:

    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation

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