Foreign Direct Investment and the Political Economy of Protection

Abstract

This paper makes the point that an import‐competing industry may not want maximal protection. The reason is that a high level of protection encourages inward foreign direct investment, which could be even less desirable than import competition. A government captured by the domestic import‐competing industry consequently will set the level of protection low enough to limit direct foreign entry. This paper also establishes results regarding the form of protection. Voluntary export restraints are shown to be the domestic industry's desired means of protection, because leaving export rents with foreigners inhibits foreign direct investment.

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