On the welfare effects of competition for foreign direct investments

This paper investigates welfare effects of subsidy competition for the location of a multinational enterprise. One of the competing regions benefits more from the inward investment but, in the absence of incentives, the multinational’s preferred location is the other, more advanced region. The paper shows that subsidies, by making the multinational switch location, may increase aggregate welfare. If the multinational exports in the absence of incentives, the welfare effects of subsidy competition may look very different. Allowing subsidies attracts the direct investment, which otherwise would not take place, in one of the two regions. Further, it intensifies competition in the market. The paper shows that the welfare increasing role of incentives may be amplified, but also that the competition effect, by hurting domestic firms, may cancel out any other positive role of incentives.