Introduction

The inflow of foreign firms and the outflow of domestic firms at the same time – the phenomenon of cross-hauling – is a well-founded empirical fact. There are many Japanese automobile firms located in the USA and at the same time there are many US firms that are located in, for example, Europe. In the international trade theory this phenomenon was first investigated by Caves (1971) and later on by Amano (1977) and Jones, Neary and Ruanne (1983). However, they considered foreign investment of the portfolio type, and, to our knowledge, no one has considered the cross-hauling of FDI.

In this chapter we consider an oligopolistic market in which a number of domestic and foreign firms produce two non-tradeable differentiated commodities. Both the number of domestic firms and that of foreign firms are affected by the government of the host country with the use of lump-sum subsidies to the domestic and foreign firms. The basic model developed here extends that of chapter 7 by endogenizing the number of domestic firms. As in chapter 7, the FDI equilibrium is specified by equating each firm's profits to an exogenous reservation level of profits which it could obtain if it penetrated an alternative market.

In this setting we examine the effect of discriminatory and uniform subsidies on the inflow/outflow of domestic and foreign firms and on the level of employment. We also find the properties of the optimal subsidies.