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Subsidies for FDI: Implications from a Model with Heterogeneous Firms

  • 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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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
Date of revision:
Publication status: Published in SMU Economics and Statistics Working Paper Series
Handle: RePEc:siu:wpaper:04-2007
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