International Rivalry in FDI Incentives and Strategic Responses

Abstract

Purpose – As globalization continues to expand since the 1990s, competition for foreign direct investment (FDI) has intensified all over the world. This paper tried to explore strategic relationships among developing countries in a race to attract multinational corporations (MNCs). Design/Methodology/Approach – This study established a game-theoretical model with three stages, where governments of potential host countries set their policies to attract MNCs and impose a tariff on imported products. In addition, MNCs make their own locational decision after realizing policy sets of incentives and tariffs. Findings – This paper found that an MNC will make a locational decision considering market size, cost advantages, FDI incentives, and tariff burdens. This paper also found that countries with a smaller market size and a weaker cost advantage are likely to raise FDI incentives to attract MNCs. In addition, the host country will raise the FDI subsidy when a non-host rival country sets a higher tariff on exports of the host country. We also found that the non-host country, which lost the race of attracting the MNC, will raise its optimal tariff rate if it has a bigger market, and the host country has a weaker cost advantage. In addition, the non-host country will raise the optimal tariff rate when the host country provides a greater subsidy to the MNC. Research Implications – One of critical findings in this study is that the host country has no first-mover advantage in a race of FDI subsidies because it needs to provide a greater subsidy to attract the MNC when it moves first by providing FDI subsidies, and then the non-host country will react by imposing a tariff against the exports of the host country to the market of the non-host country.