Targeting FDI

Abstract

We study the tax/subsidy competition between two countries to attract the FDI projects of two firms. We assume that governments lack the capacity to target every potential inward investor such that each can only bid for a single firm. When the characteristics of the two countries are common knowledge, subsidy competition never arises in equilibrium. Both governments may target the same firm if there is uncertainty as to the more profitable location for that firm’s plant, such that both governments believe they may win the competition. We also explore how such uncertainty affects the firms’ after-tax profits.