Transport infrastructure investments and competition for FDI
| Date | 01 September 2019 |
| DOI | http://doi.org/10.1111/sjpe.12203 |
| Author | Cheng Yuan,Kate Hynes,Jie Ma |
| Published date | 01 September 2019 |
TRANSPORT INFRASTRUCTURE
INVESTMENTS AND COMPETITION
FOR FDI
Kate Hynes*, Jie Ma** and Cheng Yuan***
ABSTRACT
This paper studies how transport infrastructure investments (TIIs) affect a bidding
war for a firm between two asymmetric countries within a region in a context of
imperfect competition, where TIIs play the role of a global public good, leading to
a reduction in the unit trade cost between the two countries. A number of interest-
ing results are derived from the model. In particular, TIIs can intensify fiscal com-
petition between the two countries. Surprisingly, this conventional wisdom seems
to be confirmed by this paper for the first time. Welfare implications of the model
are also examined.
II
NTRODUCTION
Competition for attracting foreign direct investment (FDI) has become com-
monplace in the past 30 years and is on the rise. On the one hand, there are a
number of reasons why a multinational enterprise (MNE) wishes to launch
new overseas plants. The investments may be driven by the market-seeking
motive. The access to cheap inputs and resources, such as labor, both skilled
and unskilled, land, raw materials, and parts and components for assembling
into final goods, is also relevant. On the other hand, national or regional gov-
ernments prefer local manufacturing to imports, as this provides cheaper con-
sumer products, creates new jobs and new demands for local services,
generates positive production externalities for local industries, and so on. As a
result, governments compete fiercely to persuade foreign investors to locate
new investments within their territories.
1
While familiar fiscal policy instru-
ments, notably the corporate tax rate and the location specific subsidy, are
used to attract foreign investors, governments may also adopt non-fiscal pol-
icy instruments to compete for FDI, notably making investments in transport
infrastructure.
*University College Dublin (UCD)
**University of International Business and Economics (UIBE)
***Peking University
1
Overviews of competition for FDI can be found in, for example, UNCTAD (1996), Oman
(2000), Charlton (2003), and Barba Navaretti and Venables (2004).
Scottish Journal of Political Economy, DOI: 10.1111/sjpe.12203, Vol. 66, No. 4, September 2019
©2018 Scottish Economic Society.
511
Transport infrastructure investments (TIIs) play a crucial role in promoting
competitiveness, enhancing connectivity both within and between countries.
Consequently, national governments invest heavily in transport infrastructure,
that is, infrastructure investments in ports, roads, railways, and airports.
2
Moreover, TIIs are often viewed as a longer-term policy than fiscal policy
tools.
3
With such investments increasing mobility between countries, the cor-
porate tax rate can be affected. Many countries, especially within the Euro-
pean Union (EU), are concerned about tax competition and the potential
‘race to the bottom in taxes’.
In this paper, we study how TIIs affect a bidding war for a firm between
two asymmetric countries in a context of imperfect competition. The situation
that we consider is as follows. An MNE from the rest of the world wants to
establish a production plant, producing and selling a homogeneous good in a
region with two countries of different market size. By locating its production
activities in one country, the MNE needs to export its goods to the other
country incurring international trade costs. Both countries have an economic
incentive to compete for the location of the MNE’s investment due to the
import substitution effects, that is, each country prefers locally produced
goods to imported goods since the price of the former is cheaper than the lat-
ter. The MNE and the two countries play a sequential game of complete
information. In the first stage, the larger and the smaller countries simultane-
ously and non-cooperatively make TIIs, which play the role of a global public
good, leading to a reduction in the unit trade cost between the two countries.
4
In the second stage, they simultaneously and non-cooperatively announce
their lump-sum subsidies/taxes to the MNE conditional on it locating within
their territories. Then, in the last stage, the MNE makes its location choice
and serves regional demands.
We derive a number of interesting results from our model. In particular,
though TIIs do not affect the equilibrium outcome of fiscal competition, that
is, the larger country always wins FDI, they do affect the larger country’s sub-
sidy/tax offered to the MNE. When the difference between the two countries’
market size is relatively small, TIIs lower the larger country’s subsidy paid to
the MNE. In this sense, such investments mitigate fiscal competition between
the two countries. When the difference between the two countries’ market size
is sufficiently large, TIIs reduce the larger country’s tax collected from the
MNE. In this sense, such investments intensify fiscal competition between the
2
PWC, Assessing the global transport infrastructure market: Outlook to 2025, https://
www.pwc.com/gx/en/transportation-logistics/pdf/assessing-global-transport-infrastructure-ma
rket.pdf.
3
Transport infrastructure investment decisions are likely to be irreversible, while fiscal pol-
icy tools are more flexible and can be viewed as a policy with less commitment value.
4
Obviously, trade costs are different from tariffs and quotas that have been substantially
lowered by successive rounds of multilateral trade negotiations, that is, GATT and WTO,
and various regional trade agreements. As a result, infrastructure-related trade cost reduc-
tions have become relatively more significant as a way of further reducing the exporting costs
of transporting products across international borders.
512 K. HYNES, J. MA AND C. YUAN
Scottish Journal of Political Economy
©2018 Scottish Economic Society
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