Foreign direct investment and industry structure

Using a differentiated oligopoly, this paper studies the effects of tax incentives on the structure of a domestic industry in terms of price, output, profit, and entry/exit, taking account of technology transfer through FDI. It is found that if the government of the host country provides more tax relief for foreign firms, it will raise total output and reduce price index. More foreign firms will enter the industry while certain existing host firms will have to exit. Consumers are better off if income is unchanged; otherwise, the change in social welfare is ambiguous in general and several sufficient conditions ensuring definite outcomes have been identified. This suggests that the government should be cautious in reducing taxes to attract FDI and should differ their preferential tax treatments across industries.