Foreign Direct Investments in Services and the Domestic Market for Expertise

Producer services such as managerial and engineering consulting can provide domestic firms with the substantial benefits of specialized knowledge that would be costly in terms of both time and money for domestic firms to develop on their own. These intermediate services are often non-traded, or costly to trade, and are best transferred through foreign direct investment. This has important implications for public policy since policies that impact on foreign direct investment are often quite different from those that impact on trade in goods. We develop a model of these services in this paper. Results show that: (1) while imported services are partial-equilibrium substitutes for domestic skilled labor, they may be general-equilibrium complements, (2) imported services lead to differential productivity effects in final goods production so that, for example, the pattern of trade in goods can reverse when FDI is permitted, and (3) the optimal tax on FDI (which we do not advocate as a practical matter) is negative.