Regional Integration, Subsidy Competition and the Relocation Choice of MNCs

Abstract Regional integration makes relocation a more attractive option for Multinational Corporations (MNC), influencing in turn the provision of investment incentives by member countries. We examine in this context the effects of subsidy competition. To do so, we model the strategic interaction between two governments offering subsidies to a MNC facing different location alternatives, which involve relocation and plant closure. Our welfare analysis shows that the combination of regional integration and subsidy competition may lead to suboptimally high levels of subsidization. We also discuss how the desirability of harmonizing subsidies (by banning them), and the net gains from integration crucially depend on technological differences, ownership, and on corporate tax rates. For instance, a simple agreement on avoiding subsidies generally raises welfare if the MNC belongs to an extra-regional country. This is not the case for a regional MNC. Lastly, we find that the gain from regional subsidy coordination increases with integration.