Governance, foreign direct investment and domestic welfare

The issue of economic governance is highly discussed pertaining to the question of industrialisation of a country, but the literature on trade and foreign direct investment (FDI) hardly pays attention to this aspect. We develop a simple model to show how good economic governance in the domestic country, reducing domestic marketing and distribution costs, affects inward FDI and domestic welfare. Whether good governance in the domestic country attracts FDI depends on the way it affects the marketing and distribution costs. The effect of good governance is ambiguous on domestic welfare and depends on the cost difference between the firms, international transportation cost and the extent of cost reduction. Our analysis reveals strategic reasons for poor governance in some situations in the presence of foreign competition.