University of HelsinkiAbstract. This paper examines the strategic interaction between a foreign direct investor, a labour union and a self-interested government in the following cases: (a) a competitive labour market, (b) bargaining over wages and employment, or (c) bargaining over wages only. The investor and the union lobby the government for taxation and labour market regulation, and the investor uses its control rights to protect its investment against expropriation. The main findings are as follows. In cases (a) and (b) above, the government can use taxation and labour market regulation as a non-distorting vehicle to press the investor’s profits to the minimum. Hence, union rights and right-to-manage bargaining (c) predict higher profits for foreign direct investment.
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