Foreign-owned Capital and Endogenous Tariffs

Foreign-owned Capital and Endogenous Tariffs

During the last two decades we simultaneously observed an important increase in investment abroad and a rush towards free-trade worldwide. This paper argues that the former may (partially) help explain the latter. In a model of endogenous determination of trade protection through lobbying, where the government is also concerned by income redistribution among owners of foreign and national factors of production, entry of foreign capital into the host country will most likely reduce the endogenous level of protection. If the elasticity of substitution between labour and capital is sufficiently small, we show that protection cannot increase after the entry of foreign capital, regardless of the form of investment abroad (acquisition of existing domestic firms, or entry by foreign firms) or its trade orientation (whether foreign capital enters the export- or import-competing sector). (JEL- Classifications: F13, F21)