Protectionism and FDI:

Protectionist trade policies are often used strategically  by countries competing to attract FDI (foreign direct investment) flows.  In  developing countries especially, FDI flows are considered desirable as they bring in scarce capital, technological  know how and newer products. Foreign multinational firms view protected markets favorably,  as protection  limits  competition and  it allows them to charge higher than world market prices.

Trade protection enhances social welfare when FDI flows  result in significant employment creation. However, there are also associated  losses. For  one, consumers suffer welfare losses when the entrant firms charge higher prices, owing to the tariff. Another potential for welfare loss arises in the long run, if the FDI results in very  little permanent transfer of knowledge and capability from  the foreign firm to the host country. Moreover, if FDI flows are simply to take advantage of protected markets, which in fact, may prove counterproductive  for the host country in  the  long run. For  it means protection would have to be granted indefinitely, as any reduction in  tariffs may  lead  to FDI outflows, as  was observed in case of Canada. cites the  example  of American firms located in Canada, which shut down and relocated after USA and Canada signed a free trade agreement.

Therefore using trade protection as a strategy to  attract FDI may not be the most efficient way to gain  from FDI flows. Rather, developing countries should attempt to  agreements with  foreign  firms that  result  in real transfers of resources,.  as  they allow them direct access to domestic markets.