Strategic Investment Policy: Role of Knowledge Spillovers

Abstract

This paper provides a theoretical background for the function of knowledge spillovers in determining the efficacy of policies targeted toward attracting FDI, which have been becoming significantly more popular in developing countries. Having characterized the strategic relationship between MNEs and local firms in host countries, we confirm that knowledge spillovers from the Northern MNEs to local firms in the South perform a crucial function in determining the Southern government's incentive to provide FDI subsidies. Additionally, when the costs of FDI policy for the host country are not appropriately calibrated to the expected benefits of the policy, the government has less incentive to provide subsidies to MNEs.