Subsidies for FDI: Implications from a Model with Heterogeneous Firms

Davin Chor ()

No 04-2007, Working Papers from Singapore Management University, School of Economics

Abstract: This paper analyzes the welfare e®ects of subsidies to attract multinational corporations, in a setting where ¯rms 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 costs of funding the subsidy program through a tax on labor income. This welfare gain stems from a selection e®ect, whereby the subsidy induces only the most productive exporters to switch to servicing the host's market via FDI. I further show that the welfare gain from a subsidy to variable costs is larger than from a subsidy to the ¯xed cost of conducting FDI, since a variable cost subsidy also raises the ine±ciently low output levels stemming from each ¯rm's mark-up pricing power.

Keywords: FDI subsidies; heterogeneous firms; fixed versus variable cost subsidies; import subsidies. (search for similar items in EconPapers)
JEL-codes: F12 F13 F23 L23 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-sea
Date: 2007-08
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Published in SMU Economics and Statistics Working Paper Series

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https://mercury.smu.edu.sg/rsrchpubupload/10702/fdisubsidyshort.pdf (application/pdf)

Related works:
Working Paper: Subsidies for FDI: Implications from a Model with Heterogenous Firms (2006)
Journal Article: Subsidies for FDI: Implications from a model with heterogeneous firms (2009)
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