Beneficial fiscal competition for foreign direct investment: transport infrastructure and economic integration

Abstract Fiscal policy competition for a multinational enterprise (MNE) resulting in the same location of firms is widely recognized as harmful owing to losses of the host government’s budget without gains from firms’ behavior. In this study, we provide a plausible explanation why fiscal competition for an MNE keeping firms’ location choices unchanged can be beneficial by incorporating governments’ decisions on public investments in transport infrastructure, such as ports, which reduces the trade costs between two competing countries. Our model divides transport costs into infrastructure-independent and infrastructure-dependent; investments in infrastructure reduce infrastructure-dependent costs. We show that fiscal competition increases countries’ investments in infrastructure under low infrastructure-independent transport costs without affecting firms’ locations. Furthermore, we show that the host country benefits from fiscal competition, although it pays a subsidy to the MNE. Moreover, as investments in infrastructure generate positive spillovers, fiscal competition that improves transport infrastructure benefits non-host countries and improves global welfare.