Resolving the Credibility Problem of an Honest Government: A Case for Foreign Investment Subsidy |
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| Authors: | Sugata Marjit,Yew Kwang Ng,Udo Broll,& Bhaswar Moitra |
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| Affiliation: | Centre for Studies in Social Sciences, Calcutta, India,;Monash University, Australia,;University of Bonn, Germany,;Jadavpur University, Calcutta, India |
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| Abstract: | We develop a simple model of direct foreign investment where the host country government cannot credibly signal its honest intention such as to stick to the contracted tax rate. The foreign firm has some prior belief regarding the ex post discretionary policies of the local government. Since the investment is completely irreversible, such a belief pattern might not induce the firm to invest in a country which badly needs it. It is shown that the host government can design a subsidy scheme which might attract foreign investment by removing the credibility problem. |
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