Tariffs and Foreign Direct Investment in a Dynamic North–South Model

Abstract This paper examines how import tariffs by a developed country (the North) and a developing country (the South) affect innovation and foreign direct investment (FDI) using a quality ladder model. We show that a Northern import tariff raises the relative wage of Northern labor, but impedes innovation and FDI. This may worsen Northern welfare. By contrast, a Southern import tariff raises the relative wage of Southern labor and promotes innovation and FDI. This can improve Southern welfare. These imply that the South has a stronger incentive than the North to impose an import tariff, which is consistent with actual observation.