Trade, FDI and Unions

In this paper we study the location behaviour of a foreign and a domestic multinational (MNE) competing a la Cournot in the domestic product market both under free trade and under the optimal domestic trade policy. Both firms produce a homogenous good using a labour intensive technology. While the domestic country is unionised, the foreign country is not. We find that when foreign wage levels are relatively low, both firms agglomerate in the South (North-South FDI) and the optimal government intervention is a zero tariff on imports. For intermediate wage levels abroad, no FDI occurs and the optimal government intervention is a tariff either lower or equal to the rent extracting tariff a la Brander and Spencer (1984). For relatively high foreign wage levels, the optimal tariff is such that both firms agglomerate in the domestic country (North-North FDI). At least three important insights evolve from this paper. Firstly, when the labour market is unionised, trade and FDI are clearly not substitutes. Secondly, when firms are footloose, the optimal domestic tariff is always lower or equal to the tariff policy in the absence of relocation possibilities. Thirdly, a tariff, deterring outward FDI or inducing inward FDI can improve domestic welfare