Export-Investment Subsidies in the Presence of Import Protection

In this paper, we investigate endogenous foreign direct investment incentives in an export sector when the tariff is exogenously given. Using a cost-benefit rule to determine export-investment incentives, authorities are shown to set subsidies which neutralize the effects of tariffs and which correspond to their welfare-maximizing level. Extending the model to two countries, we show that, depending on the level of protection, the strategic interaction between export authorities may result in an increase or a decrease in export capacity allocated to the low-wage country as compared to the outcome without export-investment subsidies.