Coordinating FDI Policies Among Host Countries

Abstract

We study the impact of foreign direct investment (FDI) policies when source firms locate some production in two host countries. By reducing its tax on multinational production, a host country can attract additional FDI, some of which is diverted from other host countries. The shift in FDI causes host wages to rise while wages elsewhere fall. The host country with the smaller labor supply per firm, and hence the lower extent of FDI absent intervention, adopts a smaller tax on multinational production. The host countries can implement larger taxes by coordinating their policies to eliminate the FDI diversion effect.