Price undertakings, VERs, and foreign direct investment: the case of foreign rivalry

Price undertakings, VERs, and foreign direct investment: the case of foreign rivalry
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  See discussions, stats, and author profiles for this publication at: Price undertakings, VERs, and foreign directinvestment  Article  · December 2006 Source: RePEc CITATIONS 0 READS 7 2 authors , including:Kaz MiyagiwaFlorida International University 84   PUBLICATIONS   844   CITATIONS   SEE PROFILE All content following this page was uploaded by Kaz Miyagiwa on 14 January 2015. The user has requested enhancement of the downloaded file. All in-text references underlined in blue are added to the srcinal documentand are linked to publications on ResearchGate, letting you access and read them immediately.   Price undertakings, VERs, and foreign direct investment   Jota Ishikawa *  and Kaz Miyagiwa ** October 2006  Abstract:  We compare the relative effect of a voluntary export restraint (VER) and a priceundertaking on foreign firmsÕ incentive to engage in FDI. We emphasize foreign rivalry as adeterminant of FDI. We show, in a model that has two foreign firms competing with a homefirm in the home country, that a price undertaking induces more FDI than a VER. The homecountry government, operating under the constraint to protect the home firm, is generally better off settling an antidumping case with a VER than with a price undertaking. Keywords : Foreign investment, price undertakings, antidumping, voluntary export restraints JEL code identification : F1 Corresponding author : Kaz Miyagiwa, Department of Economics, Emory University,Atlanta, GA 30322, U.S.A. E-mail:, Telephone: (404) 7272-6363.  #  We are grateful to Richard Baldwin, Yongmin Chen, Ig Horstmann, and seminar participants at the University of Colorado, the Graduate Institute of International Studies, and the City University of Hong Kong for helpfulcomments. We acknowledge financial support from the Ministry of Education, Culture, Sports, Science andTechnology of Japan under the 21st Century Center of Excellence Project. Jota Ishikawa also wishes to thank theJapan Economic Research Foundation, and the Japan Securities Scholarship Foundation for financial support. *  Faculty of Economics, Hitotsubashi University, Kunitachi, Tokyo 186-8601, Japan; **  Department of Economics, Emory University, Atlanta, GA, U.S.A.  1. Introduction Over the last-quarter century, use of antidumping (AD) has spread from a handful of traditional users (primarily the United States and the European Union) to more than 70countries (Prusa, 2001). In reality, however, AD petitioners often withdraw their petitions infavor of direct settlements with exporting firms or governments. For example, during the 1980-85 period over one-third of U.S. AD petitions were withdrawn in favor of voluntary exportrestraints (VERs) resulting from negotiations with foreign governments (Prusa, 1992). Duringthe same 1980-1985 period nearly half of AD petitions filed in the EU were settled through price undertakings, which are voluntary price increases offered by foreign firms to offset theinjury to EU producers due to alleged dumping (Messerlin, 1989). More recently, the U.S. andCanada have also started to settle AD cases through price undertakings.  1 In this paper we examine the relative effect of AD, VERs and price undertakings onforeign exportersÕ incentive to engage in FDI, with special emphasis on foreign rivalry as adeterminant on FDI. There is a large body of literature on Òprotection-jumpingÓ FDI. 2  Much of this literature adopts an analytical framework in which one foreign firm competes with onehome firm. Such a framework fails to reveal any influence foreign rivalry may have onincentives to engage in protection-jumping FDI. The objective of this paper is to analyze therelative effect of price undertakings and VERs on foreign firmsÕ incentives to locate productionin the home country in the presence of foreign rivalry.  1  This is because, although use of VERs to settle AD cases was prohibited under GATT in 1994 (Agreement onSafeguards, Article 11) and the existing VERs are to be phased out, price undertakings remain in full complianceunder GATT and WTO rules (Article 8). See Moore (2005) for more institutional backgrounds. 2  See, e.g., Horstmann and Markusen (1987), Motta (1992), Ishikawa (1998), and Blonigen et al. (2004).  2The literature on price undertakings is small relative to that on VERs. Recent worksinclude Vandenbussche and Wauthy (2001), Pauwels and Springael (2002), Belderbos, Vandenbussche, and Veugelers (2004) and Moore (2005). Moore (2005) compares the effect of  price undertakings and VERs in the standard model of differentiated-goods Bertrand duopolyin the absence of FDI. He finds that a VER leads to a more collusive outcome than a priceundertaking. Belderbos, Vandenbussche, and Veugelers (2004) examine a foreign firmÕsincentive to engage in FDI under an AD duty and a price undertaking, partly motivated by theaforementioned fact that EU authorities have traditionally preferred to settle AD cases with price undertakings instead of imposing AD duties. They consider a three-stage game, in whichAD authorities first decide between an AD duty and a price undertaking, the foreign firm thenchooses between exporting and FDI, and finally the foreign competes with the home firm in prices in the home market. The authors show that AD authorities choose a price undertakingover an AD duty in order to reduce the foreign firmÕs incentive to engage in FDI.The setting we analyze differs from that of Belderbos, Vandenbussche, and Veugelers(2004). We examine the relative effect of settling AD cases with price undertakings and VERson foreign firmsÕ incentives to engage in protection-jumping FDI in the presence of foreignrivalry. To capture foreign rivalry we consider a model in which two foreign firms from thesame foreign country compete with one home firm in the home market. Unlike Belderbos et al.(2004) we assume Cournot competition. As we show in Section 3, with Cournot competitionan AD duty, a VER and a price undertaking are equivalent in the absence of FDI. Thus, theassumption of Cournot competition places policy comparisons on neutral grounds by removing  3any differences among the policy options inherent in Bertrand models, as revealed in Moore(2005).The model has two foreign firms first choosing either exporting or engaging in FDI,and then competing with one home firm in the home market. The analysis offers two mainresults. A first is that a price undertaking leads to more FDI than a VER. To understand thisresult intuitively, suppose that one foreign firm, under a price undertaking, switches fromexporting to FDI while the other foreign firm chooses to export. Then, no longer subject to the price undertaking, the investing firm expands output from its local plant, thereby depressing the price for the exporter. However, since the export price cannot fall under the price undertaking,the exporter is obliged to curtail exports. Thus, FDI by one foreign firm exerts negativeexternalities on the exporting firm, giving each firm an incentive to invest before the other.With a VER, which is an export quota the foreign government Òvoluntarily accepts, if one foreign firm chooses to invest, its quota share is unused and can be redistributed to theremaining firm, thereby relaxing the quantitative constraint for the exporter. Thus, with a VER,FDI by one foreign firm gives rise to positive externalities on the exporting firm, diminishingthe incentive to engage in FDI. This difference accounts for our first result that a VER is lessconducive to FDI than a price undertaking.Our second result concerns importing country welfare. We consider a case in which thehome government settles an AD case through a VER or price undertaking under the politicalconstraint that the home firm should not be made worse off hurt as a result of the settlement.This constraint seems realistic, for otherwise the home firm would never withdraw its AD petition in favor of such a settlement. In such a setting we show that home country welfare is
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