DP3375 Trade versus Direct Investment: Modal Neutrality and National Treatment

Author(s): Bernard Hoekman , Kamal Saggi

Publication Date: May 2002

Keyword(s): foreign direct investment , trade policy , national treatment , modes of supply , neutrality , oligopoly

JEL(s): F12 , F23

Programme Areas: International Trade and Regional Economics

Link to this Page: www.cepr.org/pubs/dps/DP3375.asp

International agreements increasingly constrain the ability of governments to use trade policies whereas few constraints apply to the use of investment policies. Using a model in which a local and a foreign firm compete in the domestic market, we analyse whether the foreign firm may be forced to adopt an inefficient mode of supply (exports versus FDI) when the domestic government is constrained in its ability to use trade policy, but is free to set its FDI policy. We find that the foreign firm chooses the efficient mode of supply, even under a discriminatory output tax levied on FDI. This result suggests that the case for multilateral investment rules on efficiency grounds needs careful evaluation.