International Rivalry in FDI Incentives and Strategic Responses

Abstract

Purpose As globalization continues to expand since the 1990s, competition for foreign direct investment (FDI) has intensified all over the world. This paper tried to explore strategic relationships among developing countries in a race to attract multinational corporations (MNCs). Design/Methodology/Approach This study established a game-theoretical model with three stages, where governments of potential host countries set their policies to attract MNCs and impose a tariff on imported products. In addition, MNCs make their own locational decision after realizing policy sets of incentives and tariffs. Findings This paper found that an MNC will make a locational decision considering market size, cost advantages, FDI incentives, and tariff burdens. This paper also found that countries with a smaller market size and a weaker cost advantage are likely to raise FDI incentives to attract MNCs. In addition, the host country will raise the FDI subsidy when a non-host rival country sets a higher tariff on exports of the host country. We also found that the non-host country, which lost the race of attracting the MNC, will raise its optimal tariff rate if it has a bigger market, and the host country has a weaker cost advantage. In addition, the non-host country will raise the optimal tariff rate when the host country provides a greater subsidy to the MNC. Research Implications One of critical findings in this study is that the host country has no first-mover advantage in a race of FDI subsidies because it needs to provide a greater subsidy to attract the MNC when it moves first by providing FDI subsidies, and then the non-host country will react by imposing a tariff against the exports of the host country to the market of the non-host country.