Preferential trade agreements and tax competition for foreign direct investment

This paper examines how free-trade agreements and customs unions affect the location of foreign direct investment (FDI) and social welfare, taking into account that governments may adjust taxes and external tariffs to compete for FDI. Conditions are identified under which a free-trade agreement lead...

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Bibliographic Details
Published in:Journal of public economics 2004-12, Vol.88 (12), p.2745-2763
Main Author: Raff, Horst
Format: Article
Language:English
Subjects:
Multinational enterprises
Preferential trade agreements
Tax competition
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Summary:This paper examines how free-trade agreements and customs unions affect the location of foreign direct investment (FDI) and social welfare, taking into account that governments may adjust taxes and external tariffs to compete for FDI. Conditions are identified under which a free-trade agreement leads to FDI and under which this improves welfare. The welfare effect is shown to depend on the relative size of efficiency gains in production and government revenue losses due to tax competition. A free-trade agreement may fail to induce welfare-improving FDI, creating a role for a customs union.
ISSN:0047-2727
1879-2316
DOI:10.1016/j.jpubeco.2004.03.002