CRIEFF Discussion Paper Number 0601

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Inter-jurisdiction Subsidy Competition for a New Production Plant: What is the Central Government Optimal Policy?

Osiris J. Parcero

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Abstract
This paper models inter-jurisdiction competition for foreign direct investment and optimal government policy intervention to protect the national interest. The inter-jurisdiction competition for a multinational has the potential of favouring the multinational and of becoming detrimental for the host country. The central government wants to limit such competition but it cannot tax-discriminate between different types of multinationals.

We find that the central government would use tax policy to create asymmetries even when the underlying structure is symmetrical. This offers a novel explanation for the creation of ‘Special Economic Zones’ in many countries, which are well known to be aimed at the attraction of foreign direct investment.

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JEL Classifications
F23, H25, H71

Keywords
Bargaining, subsidy, regional, competiton, FDI

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