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Undergraduate Economic Review

Abstract

This paper considers the effect of a firm’s sales location on the relationship between tariffs, exchange rates, and the flows of Foreign Direct Investment (FDI). Much of the FDI literature assumes that an increase in the average tariff or relative exchange rate will provoke a decrease in foreign investment. This result, however, is contingent on the firm’s preference for exporting. When the majority of sales for a foreign firm are located within its own the domestic market, the impact from changes in the tariff and exchange rate are reversed. This paper further argues that the firm's pre-existing sales orientation(domestic/foreign) will be a factor that initially determines the influence of tariff and exchange rates on FDI flows. Applying the logic of the Stolper-Samuelson theorem, we develop a theoretical framework to predict a variety of consequences for wages and rental rates in US industrial sectors. Using a series of panel data regressions and a three-equation model, we generate a policy analysis that incorporates and partially validates our theory. Our final conclusions also call upon the elasticities of substitution in major industrial sectors as they correspond to changes in trade policy.

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