Politics of Competition for Foreign Direct Investment: A Simple Theory∗

We study the impact of special interest politics on competition for a multinational between two countries. We show that whether a country will win this competition is determined by both economic factors, which include for which country foreign direct investment will bring more national welfare, and in which country the multinational will make more profits; and to what extent each country’s government is influenced by domestic special interest groups. Now a country that benefits less from foreign direct investment, and is not the multinational’s preferred location, may win this competition provided that its government is far more influenced by special interest groups, so that the cost it can bear to attract the multinational can be greater than the cost its rival can bear to attract the multinational. This implies that allocative efficiency cannot be always achieved.