On the Welfare Effects of Competition for Foreign Direct Investments

This paper studies the effects of subsidy competition for the location of a multinational enterprise (MNE). We assume that a (poorer) region enjoys larger gains from the positive externalities associated with the inward investment but that the MNE would find it more profitable to locate to the other (richer) region, subsidies being equal. In this setting, subsidy competition can improve aggregate welfare relative to a policy that bans grants because it gives the chance to the region that needs it more to attract the investment. The paper analyses under which conditions this is the case, assuming either that the multinational a priori decided to invest abroad or that exports are a feasible alternative to FDI. The welfare effects of subsidy competition can, accordingly, be extremely different.