Competing for Foreign Direct Investment

Posted: 11 Oct 2000

See all articles by Pedro P. Barros

Pedro P. Barros

Universidade Nova de Lisboa

Luis M. B. Cabral

New York University (NYU) - Leonard N. Stern School of Business - Department of Economics; Centre for Economic Policy Research (CEPR)


The paper analyzes subsidy games between countries in order to attract foreign direct investment (FDI) from a third country. The winner of this game results from the interaction of two factors, relative country size and employment gains from FDI: a large (or central)country is more likely to attract FDI, and so is a country with high unemployment. The subsidy equilibrium is compared with two alternative solutions: zero subsidies and first-best subsidies. It is shown that total welfare may be greater under subsidy competition than under zero subsidies: the gains from efficient location implied by subsidy competition may more than outweigh the losses from higher subsidies. Moreover, departing from subsidy competition to zero subsidies or to first-best subsidies (without side payments) implies a gain to one country and a loss to the other. This suggests that it may be difficult to reach a consensus to move away from the status quo of subsidy competition.

JEL Classification: F21, F29

Suggested Citation

Pita Barros, Pedro Luis and Cabral, Luis M. B., Competing for Foreign Direct Investment. Review of International Economics, Vol. 8, Issue 2, May 2000. Available at SSRN:

Pedro Luis Pita Barros

Universidade Nova de Lisboa ( email )

Campus de Campolide
Lisboa, 1099-032
+351 21 383 3624 (Phone)
+351 21 388 6073 (Fax)


Luis M. B. Cabral (Contact Author)

New York University (NYU) - Leonard N. Stern School of Business - Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States
212-998-0858 (Phone)
212-998-4218 (Fax)


Centre for Economic Policy Research (CEPR)

United Kingdom

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