Subsidies for FDI: Implications from a model with heterogeneous firms

Davin Chor ()

Journal of International Economics, 2009, vol. 78, issue 1, pages 113-125

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 (search for similar items in EconPapers)
Date: 2009

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Related works:
Working Paper: Subsidies for FDI: Implications from a Model with Heterogeneous Firms (2007)
Working Paper: Subsidies for FDI: Implications from a Model with Heterogenous Firms (2006)
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Persistent link: http://EconPapers.repec.org/RePEc:eee:inecon:v:78:y:2009:i:1:p:113-125

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