Publication Type

Journal Article

Version

Preprint

Publication Date

6-2009

Abstract

This paper analyzes the welfare effects of subsidies to attract multinational corporations when firms 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 cost of funding the subsidy program through a tax on labor income. This welfare gain stems from a selection effect, whereby the subsidy induces only the most productive exporters to switch to servicing the host's market via FDI. I further show that for the same total subsidy bill, a subsidy to variable costs delivers a larger welfare gain than a subsidy to the fixed cost of conducting FDI, since a variable cost subsidy also raises the inefficiently low output levels stemming from each firm's markup pricing power.

Keywords

FDI subsidies, heterogeneous firms, fixed versus variable cost subsidies, import subsidies

Discipline

Industrial Organization

Research Areas

International Economics

Publication

Journal of International Economics

Volume

78

Issue

1

First Page

113

Last Page

125

ISSN

0022-1996

Identifier

10.1016/j.jinteco.2009.01.013

Publisher

Elsevier

Copyright Owner and License

Author

Creative Commons License

Creative Commons Attribution-Noncommercial-No Derivative Works 4.0 License
This work is licensed under a Creative Commons Attribution-Noncommercial-No Derivative Works 4.0 License.

Additional URL

http://doi.org/10.1016/j.jinteco.2009.01.013

Comments

Revise and Resubmit, Journal of International Economics

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