Introduction

A local content regulation, viz., a restriction on the use of inputs by FDI, is clearly detrimental to the efficiency of foreign firms and this in turn is reflected in a higher price of the good and therefore a lower level of consumers' surplus, as shown in chapters 7 and 8. Why do governments, then, nevertheless impose such restrictions?

One of the main reasons for the imposition of a local content requirement is to stimulate the local economy in general and to create employment in particular. There is thus a conflict of interest between consumers on one hand and workers on the other. The government has to balance the two conflicting interests in deciding on the optimal level of the local content requirement. However, the conflict of interests also gives rise to lobbying by interest groups for a higher level of restriction on the foreign firms than otherwise would be. Therefore, in analysing local content requirements, it is imperative that one models lobbying activities explicitly.

In this chapter we consider an oligopolistic industry in which a number of foreign firms compete in the market for a non-tradeable commodity in a host country. The number of foreign firms, and hence FDI, can be affected by the host country's local content requirement. The market structure of the present model, in which the existence of any domestic firm is assumed away, is a special case of the model developed in chapter 7. However, we extend it by allowing lobbying activities.