Double-Edged Incentive Competition for Foreign Direct Investment

This paper studies the impact of special interest lobbying on competition between two countries for a multinational in a common agency framework. We examine the following questions. On the positive side, is special interest lobbying a determinant of competition for FDI? If so, how does this work and how does it affect the equilibrium subsidy for attracting FDI? On the normative side, what are the welfare effects of FDI competition when special interest lobbying is present? Is allocative efficiency always achieved? We argue that special interest lobbying provides an extra political incentive for a government to attract FDI. We show that compared to the benchmark case where governments maximize national welfare, now (1) an economically disadvantageous country has a chance to win the competition; (2) the equilibrium subsidy for attracting FDI is higher than in the benchmark case; (3) allocative efficiency cannot be always achieved