DP5379 Competing for a Duopoly: International Trade and Tax Competition

Author(s): Ben Ferrett, Ian Wooton
Publication Date: November 2005
Keyword(s): foreign direct investment, market size asymmetries, oligopoly, tax competition
JEL(s): F12, F23, H25, H73
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5379

Oligopoly is empirically prevalent in the industries where MNEs operate and national governments compete with fiscal inducements for their FDI projects. Despite this, existing formal treatments of fiscal competition generally focus on the polar cases of perfect competition and monopoly. We consider the competition between two potential host governments to attract the investment of both firms in a duopolistic industry. Competition by identical countries for a monopoly firm's investment is known to result in a 'race to the bottom' where all rents are captured by the firm through subsidies. We demonstrate that with two firms, both are taxed in equilibrium, despite the explicit non-cooperation between governments. When countries differ in size, a single firm will be attracted to the larger market. We explore the conditions under which both firms in the duopoly co-locate and when each nation attracts a firm in equilibrium. Our results are consistent with the observed stability of effective corporate tax rates in the face of ongoing globalization, and our analysis readily generalizes to many specifications with oligopoly in the product markets.