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Productivity and Taxes as Drivers of FDI

Productivity and Taxes as Drivers of FDI

This is a

This is a selection-condition equation for greenfield FDI. In contrast to the M&Acase, there is a role played here by the aggregate productivity factor in the source-country( AS). A positive shock toASincreases the likelihood of the source-country entrepreneursof staying at home, thereby reducing the likelihood of greenfield FDI flows from countryS to H.Note that in a many-country world, an entrepreneur from source country Schooses to invest in host country H, if the latter offers the most profitable investment.Also, she may need to outbid competitors from other source countries (for instance, in thecase of acquiring a concession from the host-country government to operate something ).∗In this case, V( A , C , w )H nH Hin the selection-condition equation ( 15 ) must be the∗maximum over all V( A ', C ', w ')H nH Hfor potential other host countries:V( A , C , w ) = argmax V( A ', C ', w ') > V( A , C , w ),∗ ∗ ∗H nH H H ' ∈DH nH H S S S( 15’ )where D is the set of potential host countries in which the entrepreneurs of sourcecountryS can outbid all competing entrepreneurs from other potential source countries. 9Each entrepreneur in the source country, who decides to actually make agreenfield FDI in host-country H, invests according to the marginal productivityconditions. Aggregation over these entrepreneurs from source-country S provides a flowequation of greenfield FDI from S to H.As we have seen, the host-country aggregate productivity factor (AH) affectspositively the notional FDI flows from source countries in the case of M&A flows;9 Eaton and Kortum (2002) applied the probability theory of extremes to provide a tractable form for aselection-condition equation in a similar context.15

whereas the source-country aggregate productivity factor (flows. At the same time, a positive shock toAS) has no effect on theseAHmay reduce the likelihood of havingM&A FDI flows to the host-country H (because of general equilibrium effects on wagesin the host-country); again,FDI, a positive shock toAShas no effects on these flows. In the case of greenfieldAHhas positive effects both on the notional FDI flows to hostcountryH and on the likelihood of these flows to actually materialize. A positive shock toASdoes not affect the notional flows to host-country H, but it reduces the likelihood ofsuch flows to occur at all. Note also that the likelihood of having greenfield FDI flowsfrom country S to country H is negatively affected by positive productivity shocks in allother potential host countries ( A ' ). 10H3. Source and Host Corporate TaxationThe economic literature has dealt extensively with the effects of taxation oninvestment, going back to the well-known works of Harbeger (1962) and Hall andJorgenson (1967). Of particular interest are the effects of international differences in taxrates on foreign direct investment; see, for instance, Auerbach and Hassett (1993), Hines(1999), Desai and Hines (2001), De Mooij and Ederveen (2001), and Devereux andHubbard (2003).In this section we attempt to provide a new look at the mechanisms through whichcorporate tax rates influence aggregate FDI flows in the setup adopted here of twofold10 A comprehensive study of the latter effects ( AH' ) is not available. We ignore these effects in theempirical investigation.16

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