Abstract
It is well known that high tariffs can induce foreign direct investment or ‘tariff jumping’. This paper analyzes tariff jumping in the context of a host government which can set specific tariffs and taxes subject to the credibility constraint that the chosen levels be optimal once capital is irreversibly in place. The foreign multinational is assumed to choose its location and level of investment strategically, taking into account the induced tax and tariff levels. In the presence of unemployment, the optimal tariff exceeds the optimal tax for any given level of capital investment, leading to foreign direct investment.
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