Local content requirements, vertical cooperation, and foreign direct investment

We examine the effects of a local content requirement (LCR) in the context of potential vertical cooperation between a host country''s upstream and downstream producers and foreign direct investment (FDI) in upstream manufacturing by a foreign multinational. The relationship- specific investment which sustains cooperation also allows the host country firms to commit to a FDI pre-empting strategy through manipulation of the price of intermediates supplied to the foreign firm. It is found that depending on the presence of economies of scale in the upstream industry and the cost advantage of the multinational, the LCR can either induce cooperation and increase host country profits, or reduce the incentives to cooperate and induce FDI. In the latter case, the LCR reduces profits of all firms but benefits consumers.