FDI Policies Under Shared Factor Markets

Note: The following is a description of the paper and not the actual abstract. We consider a model where firms from a high-cost source country shift some of their production to a low-cost host country. Firms earn profits since the output market is a Cournot oligopoly. Due to a fixed supply of skilled labor in each country, such foreign direct investment (FDI) raises the host wage and reduces the source wage. A subsidy to FDI results in higher profits for source firms but lower profits for host firms. Thus, each country experiences conflict in setting its policy toward FDI. Workers favor inward FDI but local firms resist it in the host country, while firms favor outward FDI but workers resist it in the source country. We characterize how the optimal host and source policies toward FDI depend on resource supplies, resource demand, and ownership of firms across countries. Subsidies can be effective in raising national welfare, even in the presence of shared factors available in fixed supply, provided the opportunity to undertake FDI is present