Backfired Deregulation of Foreign Ownership Restrictions under Fiscal Competition for Foreign Direct Investment

Parallel to tax/subsidy competition for foreign direct investment (FDI), we have recently observed the relaxation of FDI restrictions, especially in developing countries, and mixed outcomes of inward FDI. This study examines how foreign-ownership regulation affects a multinational enterprise's (MNE's) location choice under fiscal competition. Consistent with the literature, our model shows that the larger country tends to host the MNE without FDI regulation due to the market-size advantage. With FDI regulation, however, irrespective of the market-size gap, the smaller country can attract the MNE under certain circumstances. Interestingly, our result indicates that looser FDI regulation in the larger country can induce the MNE to choose the smaller country as the production location because this reduces the local (potential) partner firm's profits and directs the local firm to decline the joint venture offer.