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 better governance affects inward FDI and domestic welfare. We find that whether better governance in the domestic country attracts inward FDI depends on the way it affects the costs of the firms. The effect of better governance is ambiguous on domestic welfare and depends on the marginal cost difference between the firms, transportation cost and the extent of cost reduction through better governance. Our analysis reveals a strategic reason for poor governance in the presence of foreign competition