Competition for FDI with Vintage Investment and Agglomeration Advantages

Abstract

Countries compete for new FDI investment, whereas stocks of FDI generate agglomeration benefits and are potentially subject to extortionary taxation. We study the interaction between these aspects in a simple vintage capital framework with discrete time and infinite horizon, focussing on Markov perfect equilibrium in stationary strategies. We show that the tax revenue in the equilibrium is substantial, and higher on "old" FDI than on "new" FDI, even though countries are not allowed to use discriminatory taxation. Moreover, the agglomeration advantage is valuable, but is exploited in the short run and can be unstable over time.

Keywords: dynamic tax competition, vintage capital, agglomeration, foreign direct investment, bidding for firms

JEL Classification: F21, H71