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PLANT LOCATIONS WITH REVERSE IMPORTS IN THE PRESENCE OF UNEMPLOYMENT

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Abstract

In this paper, we develop a location model of two multi-national firms (MNFs) with reverse imports and examine the consistency of MNFs' location shift in terms of social welfare in the foreign direct investment (FDI) source (home) country. If fixed costs are incurred in FDI, trade liberalization induces a gradual overseas production by MNFs. When an unemployment problem exists in the home country, firms tend to undertake FDI at a lower level of trade liberalization, compared to the socially desirable level. As a result of the presence of a foreign rival firm, FDI by a home firm benefits the home country given that another home firm chooses foreign production. On the other hand, because of the negative effect of unemployment on social welfare, FDI by a home firm hurts the home country given that another home firm chooses domestic production. Hence, the government of the FDI source country might use subsidy-tax policies in order to induce the MNFs to choose a socially desirable production location.

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