The Direct Effects of Trade Liberalization on Foreign Direct Investment: A Partial Equilibrium Analysis

Abstract

We develop a partial-equilibrium model for analyzing the effect of trade barriers and their removal on the level of foreign direct investment. These changes operate through three channels. Lowering barriers to the firms' exports and to their imports of intermediate goods tends to stimulate FDI, while lowering barriers to imports of competing goods tends to discourage FDI. We simulate tariff elimination between the United States and the United Kingdom for eleven manufacturing sectors, and then add a tariff between the United Kingdom and the continental EU at the EU's MFN rate. The results highlight the importance of trade in intermediate goods in assessing trade-FDI linkages.