On the Role of Local Content Requirement in Defusing the Threat of Quid-Pro-Quo FDI

We analyze local content requirement (LCR) and tariff in a two-country model of vertical market-structure with endogenous foreign direct investment (FDI). The foreign firm chooses whether to export or to undertake FDI. The host country anticipates the potential for FDI and selects tariff with or without LCR rate accordingly. Without LCR, the FDI imposes a threat on the host country and the threat exerts a tariff-liberalizing pressure. This FDI is often coined as quid-pro-quo FDI in the literature. In contrast, we show that with LCR the host government can defuse the threat of quid-pro-quo FDI