Strategic export policy with foreign direct investment and import substitution

Abstract

The paper examines discretionary and strategic foreign direct investment (FDI) incentives in the export sector relative to a non-interventionist policy. The analysis is based on a two-country model with both countries seeking to attract FDI. Countries differ in cost levels and in their levels of tariff protection on intermediate inputs. A shift in the trade policy regime toward the strategic promotion of exports results in a decrease in FDI allocated to the low-cost country when it has a low level of protection on intermediate inputs, and an increase in FDI when it has a high level of protection on intermediates inputs. Furthermore, even if FDI increases with export policy activism relative to non-intervention, welfare may be lower.