Subsides for FDI: Implications from a Model with Heterogeneous Firms

Davin Chor

Finance Working Papers from East Asian Bureau of Economic Research

Abstract: This paper analyzes the welfare effects of subsidies to attract multinational corporations, in a setting where 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 costs 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 the welfare gain from a subsidy to variable costs is larger than from a subsidy to the fixed cost of conducting FDI, since a variable cost subsidy also raises the ineciently low output levels stemming from each firm'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)
Date: 2007-01
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Related works:
Journal Article: Subsidies for FDI: Implications from a model with heterogeneous firms (2009)
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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