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Foreign-owned capital and endogenous tariffs

  • Olarreaga, Marcelo

During the past two decades there has been an important increase in investment abroad and a worldwide rush toward free trade. The author argues that the increase in investment abroad may partially explain the worldwide rush toward free trade. In a model of endogenous determination of trade protection through lobbying - where the government is also concerned about income redistribution among owners of foreign and national factors of production --foreign capital's entry into a host country will probably reduce the endogenous level of protection. If the elasticity of substitution between labor and capital is small enough, the author shows, protection cannot increase after the entry of foreign capital, regardless of the form of investment abroad (whether through acquisition of existing domestic firms or the entry of foreign firms) or its trade orientation (whether foreign capital enters the export or import-competing sectors). There will either be increased counter-lobbying for protection by the export sector or reduced lobbying for protection in the import-competing sector, because of the scale effect associated with an increase in the equilibrium wage. If foreign entry occurs in the import-competing sector, protection might increase because of the scale effect, but under reasonable assumptions about the value of the elasticity of substitution between labor and capital, protection will also fall.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2205.

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Date of creation: 31 Oct 1999
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Handle: RePEc:wbk:wbrwps:2205
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  1. Helpman, Elhanan, 1995. "Politics and Trade Policy," CEPR Discussion Papers 1269, C.E.P.R. Discussion Papers.
  2. Schweinberger, Albert G & Vosgerau, Hans J, 1997. "Foreign Factor Ownership and Optimal Tariffs," Review of International Economics, Wiley Blackwell, vol. 5(1), pages 1-19, February.
  3. Grossman, Gene & Helpman, Elhanan, 1993. "Protection for Sale," CEPR Discussion Papers 827, C.E.P.R. Discussion Papers.
  4. Grether, Jean-Marie & de Melo, Jaime & Olarreaga, Marcelo, 1999. "Who determines Mexican trade policy?," Policy Research Working Paper Series 2187, The World Bank.
  5. Konishi, Hideo & Saggi, Kamal & Weber, Shlomo, 1999. "Endogenous trade policy under foreign direct investment," Journal of International Economics, Elsevier, vol. 49(2), pages 289-308, December.
  6. Horstmann, Ignatius J. & Markusen, James R., 1992. "Endogenous market structures in international trade (natura facit saltum)," Journal of International Economics, Elsevier, vol. 32(1-2), pages 109-129, February.
  7. Ellingsen, Tore & Warneryd, Karl, 1999. "Foreign Direct Investment and the Political Economy of Protection," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 40(2), pages 357-79, May.
  8. Hillman, Arye L, 1982. "Declining Industries and Political-Support Protectionist Motives," American Economic Review, American Economic Association, vol. 72(5), pages 1180-87, December.
  9. Hillman, Arye L & Ursprung, Heinrich W, 1993. "Multinational Firms, Political Competition, and International Trade Policy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 34(2), pages 347-63, May.
  10. Hillman, Arye L. & Ursprung, Heinrich W., 1996. "The political economy of trade liberalization in the transition," European Economic Review, Elsevier, vol. 40(3-5), pages 783-794, April.
  11. Marcelo Olarreaga, 1998. "Tariff Reductions under Foreign Factor Ownership," Canadian Journal of Economics, Canadian Economics Association, vol. 31(4), pages 830-836, November.
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