Do Higher Tari s Trigger Foreign Direct Investment ? A New Look

In this paper we investigate how strategic aspects in uence the choice between exporting and servicing foreign markets by setting up a plant in the foreign country. We show that tari s on imports in conjunction with the size of the set up costs incurred while setting up plants and the size of the foreign market will determine whether domestic rms which face competition from a foreign rm will choose to deter foreign direct investment (FDI), prevent exports or may accommodate either form of penetration of a foreign rm in their market. Our analysis reveals that there is no simple relationship between the size of the tari and the propensity of foreign rms to engage in foreign direct investment. Higher tari s may result in exports rather than FDI. Furthermore, due to actual competition among domestic rms while facing potential competition in the form of FDI, a rise in tari s may lead to a rather moderate increase in output of the import competing domestic producers when compared to the case where the threat of foreign investment is absent. Please send correspondence to: Shabtai Donnenfeld York University Department of Economics 4700 Keele Street North York, ONT M3J 1P3 Canada Phone (416) 736-2100 ext. 22407 Fax (416) 736-5987 An earlier version of this paper was presented at seminars at New York University, University of Toronto and at the International Research Conference Carnegie Bosch Institute. Donnenfeld thanks Carnegie Bosch Institute for nancial support.