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Subsidies for FDI: Implications from a Model with Heterogeneous Firms

Listed author(s):
  • Davin Chor

    ()

    (School of Economics, Singapore Management University)

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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File URL: https://mercury.smu.edu.sg/rsrchpubupload/10702/fdisubsidyshort.pdf
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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
Publication status: Published in SMU Economics and Statistics Working Paper Series
Handle: RePEc:siu:wpaper:04-2007
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  1. Svetlana Demidova & Andrés Rodríguez-Clare, 2007. "Trade Policy under Firm-Level Heterogeneity in a Small Economy," NBER Working Papers 13688, National Bureau of Economic Research, Inc.
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  12. Karolina Ekholm & Rikard Forslid & James R. Markusen, 2007. "Export-Platform Foreign Direct Investment," Journal of the European Economic Association, MIT Press, vol. 5(4), pages 776-795, 06.
  13. Ottaviano, Gianmarco I.P. & van Ypersele, Tanguy, 2005. "Market size and tax competition," Journal of International Economics, Elsevier, vol. 67(1), pages 25-46, September.
  14. Michael Devereux & Rachel Griffith, 1996. "Taxes and the location of production: evidence from a panel of US multinationals," IFS Working Papers W96/14, Institute for Fiscal Studies.
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  26. repec:hal:journl:halshs-00179815 is not listed on IDEAS
  27. Dasgupta, Partha & Stiglitz, Joseph E, 1988. "Learning-by-Doing, Market Structure and Industrial and Trade Policies," Oxford Economic Papers, Oxford University Press, vol. 40(2), pages 246-268, June.
  28. G. D. A. MacDougall, 1960. "THE BENEFITS and COSTS OF PRIVATE INVESTMENT FROM ABROAD: A THEORETICAL APPROACH," The Economic Record, The Economic Society of Australia, vol. 36(73), pages 13-35, 03.
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  30. Ronald W. Jones, 1967. "International Capital Movements and the Theory of Tariffs and Trade," The Quarterly Journal of Economics, Oxford University Press, vol. 81(1), pages 1-38.
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