Foreign Direct Investment and the Single Market

∏" = π(0) -y+(n-l)π(r)                       (2)

The difference between this and the profits from exporting can, from (1), be written as:

∏^w-∏^x = γ(r√), where:     (3t,f) ≡ π(O) -/"π(r)        (3)

+ -

The function γ(t,f) measures the net gain from tariff-jumping into an individual union market:
supplying it from a local plant rather than incurring the unit cost t of supplying it from
outside. It is clearly increasing in t and decreasing in f. Other things equal, the multinational
will engage in FDI if and only if γ(t,f ) is positive.

However, under the assumptions made so far, it does not make sense to locate in only
one union country. The total profits from locating plants in m member countries (m<_n),
denoted by Π^Fm, equal:

∏^λm = (4 [π (O) (4) + (4-т) π (4                        ⁽⁴⁾

Now the firm enjoys improved access to m markets (though it must incur the fixed costs of
constructing m plants), and unchanged access to the other n-m. Extending the logic which
led to (3), the profit gain from establishing an additional plant is:

∏⅛-₁F>-ι = _γ5)J)                        (5)

Clearly, if it pays to set up a plant in one union country (i.e., if γ(t,f ) is positive), it pays to
set up in all. The only form which FDI takes in this case is a different plant located in each
of the n member countries. This leads to total profits denoted by Π^Fn:

(I^irn = n[π(0)√]                               (6)

Because all union countries are identical, and because there is no production cost advantage
to locating inside the union, it never pays to produce with less than n plants.

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