DP2772 Trade, FDI and Unions
In this Paper we study the location behaviour of a foreign and a domestic footloose firm competing in output in the domestic product market. Both firms produce a homogenous good using a labour intensive technology. While the domestic country is unionized, the foreign country is not. Location equilibria are studied as a function of the foreign wage level, both under free trade and under an optimal domestic trade policy. We find that when foreign wage levels are relatively low, both firms agglomerate in the foreign market (North-South FDI) and the optimal government intervention by the North is a zero tariff on imports from the South. For intermediate wage levels abroad, both firms prefer to locate in their own market and the optimal domestic government intervention is a positive tariff on foreign imports. For relatively high foreign wage levels, the optimal tariff policy is such that both firms agglomerate in the domestic country (North-North FDI).