Foreign Direct Investment, Endogenous Tariffs, and Preferential Trade Agreements.

Abstract:     
This paper examines the complementarity between international trade and investment policies. A simple two country model demonstrates that export-platform FDI induces unilateral tariff liberalization by the FDI-source country, suggesting that international capital mobility may substitute partially for multilateral forums such as the WTO in achieving efficient tariffs. A multi-country extension of the model in which countries can compete for FDI via investment subsidies then develops an efficiency argument in favor of discriminatory tariff allowances such as GATT Article XXIV or Generalized Systems of Preferences. When small countries can earn preferential tariff treatment from a large trading counterpart by encouraging local export-platform FDI, the equilibrium aggregate FDI level will be higher and the tariff level lower when discriminatory tariffs are possible than when they are not.

Keywords: foreign direct investment, tariffs, terms of trade, preferential trade agreements, GATT/WTO

JEL Classifications: f1, f2

Working Paper Series