Firm heterogeneity, foreign direct investment and the hostcountrywelfare: Trade costs vs. cheap labor

Whether higher productivity of the foreign firm increases host countrywelfare depends on whether the reason for foreign direct investment (FDI) is to savethe trade cost or to get the advantage of cheap labor. We show that, if the reason forFDI is to get the advantage of cheap labor, higher productivity of the foreign firmmay reduce host-country welfare. Higher productivity of the foreign firm alwaysincreases (may reduce) host-country welfare if the reason for FDI is to save tradecost, while the trade cost implies transportation cost (tariff)...