Endogenous trade policy under foreign direct investment

Using Bernheim and Whinston (1986) common agency game, we endogenize trade policy in a duopoly composed of a domestic firm and a foreign firm, where b oth firms influence the domestic government's trade policy via their contri butions. The foreign firm can jump over trade restrictions by undertaking f oreign direct investment (FDI) in the domestic market. The government prefe rs a voluntary export restraint (VER) to a tariff for two reasons. First, a VER leads to higher contributions from the foreign firm than a tariff. Sec ond, a VER provides a higher level of protection to the domestic firm witho ut generating FDI by the foreign firm. (C) 1999 Elsevier Science B.V. All r ights reserved. JEL classification: F12; F13; F23.