Welfare effects of foreign direct investment: Cost saving vs. signaling

We compare the effects of two types of foreign direct investment (FDI) (viz., FDI for trade cost saving and FDI for signaling foreign cost of production) on consumer surplus, profit of the host-country firm and host-country welfare. We show that the effects are dramatically different. If the reason for FDI is to save trade cost, FDI (compared to export) always makes the consumers better off and the host-country producer worse off, while the effect on host-country welfare is ambiguous. However, if the FDI is to signal the foreign cost of production, FDI (compared to export) always makes the host-country producer better off and increases host-country welfare, while it makes the consumers almost always worse off.