- This paper examines a setting where foreign direct investment (FDI) shifts demand for an intermediate good from the source to the host country. A domestic and a foreign firm choose between exports or FDI, always sourcing the intermediate locally. We show that by increasing the price of the intermediate, outward FDI can act as a cost-raising strategy for a firm and that attracting FDI can raise host country welfare. Two-way FDI is the equilibrium when the countries have similar market sizes. However, such FDI reduces global welfare relative to two-way exporting since it eliminates indirect competition between suppliers. 2005 Kiel Institute for World Economics.