Profit Tax and Firm Mobility in a Three‐country Model

Abstract

We construct a three-country model that incorporates international relocation by imperfectly competitive firms and examine both the effects of each country's profit tax reduction on the consumption and welfare of all countries, and the incentive for the countries to decrease the profit tax. In such a model, both the terms of trade and international relocation of firms offer the key to understanding the impacts of one country's profit tax policy. In particular, we note that the relocation of firms from the other two countries is positively related to the wage incomes of the third country through a shift in labour demand, and the terms-of-trade improvement is not only positively related to the wage incomes, but also negatively related to profit incomes through a shift in world consumption demand. We show that (i) in a three-country world economy, regardless of the reduction's source, the profit tax reduction of each country leads to relocation of firms away from foreign countries toward its own economy and deteriorates the terms of trade of its economy and (ii) this becomes a 'beggar-thy-neighbour' policy in the sense that it lowers the welfare of the other foreign countries. Copyright 2010 The Author. Journal compilation 2010 Blackwell Publishing Ltd/University of Adelaide and Flinders University.

Restrictions on Foreign Investments and the Relocation of Firms

“…When foreign investment is not restricted, there are various factors that explain why firms engage in FDI such as reducing wage costs, entering foreign markets, establishing cooperation agreements between firms, R&D investments and public ownership of firms (see for example Mucchielli & Saucier, ; Petit & Sanna‐Randaccio, ; Norbäck, ; Blomström & Kokko, ; Fumagalli, ; Johdo, ; Bárcena‐Ruiz & Garzón, , ).…”