Foreign Direct Investment and the Single Market

Although introducing country heterogeneity complicates the analysis in detail, the
broad thrust of the results of Section 2 continues to apply. A reduction in internal tariffs
makes FDI more likely; and, given that FDI takes place, the optimal number of plants falls.
Note a further implication. The literature on multinationals has often distinguished between
vertical and horizontal multinationals, and has suggested that the latter’s location decisions
are determined mainly by market access rather than by cost considerations. (See Markusen
(1995) for example.) In this model, however, multinational activity is purely horizontal, and
yet cost considerations are crucial in determining where in the union a new plant will locate.

5. Conclusions

This paper extends the theory of multinational corporations to explore the effects of
internal trade liberalisation by a group of countries on the level of inward direct investment.

The analysis identifies three distinct influences on how a multinational corporation
chooses to serve the union markets. First is the tariff-jumping motive. As is familiar from
earlier literature, this favours FDI over exporting the higher the external tariff and the lower
the fixed costs of a new plant. Less familiarly, reductions in internal tariffs reduce the tariff-
jumping incentive to establish more than one union plant, and so encourage plant
consolidation. Second is the export platform motive. As internal tariffs fall, this favours FDI
with only a single union plant relative to exporting. It may also induce a firm which has
never exported to invest: this is more likely for multinationals with high access and fixed
costs, and which face less competition from union firms. Finally, reduced internal tariffs lead
to increased competition from domestic firms, which dilutes both the tariff-jumping and export
platform motives. This works against both FDI and exports and may lead to the "Fortress
Europe" outcome of multinationals leaving union markets even though external tariffs are

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