Location Clusters, FDI and Local Entrepreneurs: Consistent Public Policy
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Location Clusters, FDI and Local Entrepreneurs: Consistent Public Policy João Ricardo Faria 1
Received: 12 November 2014 / Accepted: 25 June 2015 # Springer Science+Business Media New York 2015
Abstract In order to formulate public policy consistent with attracting foreign investment and fostering regional development, this paper analyzes a model of local entrepreneur’s choices when they are affected by foreign direct investment (FDI) spillovers. FDI is determined by economies of agglomeration, market size, taxes, labor, and location costs. It is shown that location costs of the multinationals (MNE) affect the optimal quantity of MNE capital and regional development, while location costs and preferences of local entrepreneurs affect only their location and consumption. Other determinants of MNE location also impact regional development. The main policies advocated are as follows: provision of logistical infrastructure; creation and/or nurturing of pro-market institutions; non-discretionary policies; reduction of statutory tax rate; incentives to universities and research centers. JEL Classification F23 . F43 . R3 Keywords Multinationals . Regional policy . Spillovers
Introduction Regional public policies have been considered essential to attract economic activity to develop lagging regions. Foreign investors have been one of the main targets of regional public policies because they bring new technologies, products, and management practices that are believed to increase local productivity, diversify local markets, and increase regional income. Some of these regional policies such as subsidies for job creation, temporary exemption of local taxes, discretionary government grants, low corporate taxes, etc., may not have the desired impact, either because they do not have
* João Ricardo Faria [email protected] 1
University of Texas at El Paso, 500 W.Univ.Ave., El Paso, TX 79968, USA
J Knowl Econ
the expected sign or because they are too small, or even negligible. In order to better understand and examine public policy consistent with attracting foreign investment and regional development, we need a work horse model that allows the identification and evaluation of all possible regional public policies designed to attract foreign direct investment (FDI). This is the objective of this paper; we propose and analyze such a model. In this paper we focus on the behavior of local entrepreneurs and their relation with foreign direct investment. By assuming rather simple positive spillover effects to model economies of agglomeration from multinational enterprises (MNE) on local entrepreneurs, we derive the formation of spatial location clusters showing that MNE location decisions determine the optimal location of domestic entrepreneurs. In addition the model allows the study of the determinants of regional development and the impact of public policies that may affect the location decisions of MNEs. The model yields a complete characterization of FDI and the optimal behavior of local entrepreneurs. It allows us to study the
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