Foreign Direct Investment and the Single Market

Π^f7 = ∏^x + γ°(r√), where:      γ^β(r,/) ≡ πⁿ-/-π[r,(n-l)r]    (24)

Here γ^D(t,f) denotes the gain from tariff-jumping which results in the multinational becoming
a duopolist in the new market, earning duopoly profits π^D (equal to 1/9 with linear demands)
there. In this case too, if γ^D(t,f ) is positive, then it pays to establish a plant in each market,
and the multinational, like the union firms, ceases to export within the union.

In summary, the presence of domestic firms reduces the multinational’s profits in all
regimes, as we would expect. However, it does not change the qualitative pattern of the
equilibria relative to what was found in Section 2. The dashed lines in Figure 4 delineate the
regions corresponding to different modes of serving the union. Region O corresponds to
tariffs above t and fixed costs above 1/9, the threshold at which the profits from FDI, with
a plant in each country and no intra-union exports, are zero. The remainder of the space is
occupied by regions X and Fn, with the dividing line between them corresponding to the case
where either γ(t,f) or γD(t,f) is zero, i.e.:

'l+(n-l)r^∣2

n+2

The kink in this curve at t=⅛ reflects the exit of partner-country firms from each market, so
that intra-union exports cease in the Fn regime, whereas they continue until t=½ in the X
regime.

3.3 A Reduction in Internal Barriers

Suppose now that internal barriers are lowered. As in Section 2, as long as internal

tariffs remain above the prohibitive level of 0.5, no intra-union trade by any firms is possible.

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