Competing for a duopoly: international trade and tax competition

We analyse the tax/subsidy competition between two potential host governments to attract the plants of firms in a duopolistic industry. While competition between identical countries for a monopolist’s investment is known to result in subsidy inflation,two firms can be taxed in equilibrium with the host countries appropriating the entire social surplus generated within the industry, despite explicit non-cooperation between governments. Trade costs mean that the firms prefer dispersed to co-located production,creating these taxation opportunities for the host countries. We determine the country-size asymmetry that changes the nature of the equilibrium, inducing concentration of production in the larger country.