National Treatment and the Choice Between Exports and FDI

Abstract

Abstract International trade agreements increasingly constrain the ability of governments to use trade policies. Fewer international constraints apply to the use of investment policies, although there is discussion about negotiating such disciplines both regionally and multilaterally. Since firms compete in foreign markets via both exports and foreign direct investment(FDI), the following question arises: can constraints on the use of only one type of policy (trade or FDI) induce firms to adopt inefficient modes of supply when serving foreign markets? We address this question in a model in which a local and a foreign firm compete in the domestic market. In the model, the domestic government's trade and/or FDI policies as well as the foreign firm's choice between exports and FDI are endogenous. We show that even if the domestic government is constrained only in its ability to use trade (FDI) policy, and is free to set its FDI (trade) policy, the foreign firm chooses the efficient mode of supply. The key point is that it is never in the interest of the domestic government to set policies in a manner that leads the foreign firm to adopt an inefficient mode of supply.