Taxation on Fixed Foreign Direct Investment and International Commodity Trade as a Potential Protector

Abstract

This paper presents a model to explain why foreign direct investment (FDI) is possible even in the closed loop game where no precommitment on future FDI tax rate is available. Using a simple two-period model, we explain how international commodity trade between the capital-exporting country and the capital-importing country can be a passive leverage to protect the fixed FDI from being confiscated. We derive the necessary and sufficient conditions to guarantee an interior FDI tax rate in the closed loop game.