We contrast import substitution and FDI liberalization as alternative development strategies in the presence of agglomeration. We develop a two-country model where firm-level increasing returns, inter-firm linkages, & transport costs generate country-specific external economies in manufacturing. Industry agglomerates in one country, while the other (LDC) enjoys lower welfare. We show that multinationals might operate profitably in the LDC (even if indigenous firms cannot) since their cost advantage, reflecting firm-level scale economies, helps them overcome the disadvantage of a small local industrial base. In turn, MNC entry expands this industrial base, encouraging further entry & promoting income convergence. LDC tariffs, instead, increase both domestic demand for local manufacturers, and the cost of imported intermediates used in local production for both domestic and foreign markets. Hence, tariffs may reinforce the incentive for industry to cluster in the North.