Foreign Direct Investment and the Single Market



and Norman (1993, 1996). A feature of most papers in this tradition is that all firms are
assumed to be equally likely to engage in FDI. This symmetry is theoretical pleasing, but it
tends to lead to highly complex analyses. My approach, which assumes the potential
multinational has a first-mover advantage, is more restrictive. However, it allows a clearer
focus on the key economic issues and extends straightforwardly to an arbitrary number of
countries. It also fits well the case of a foreign firm which possesses some technological or
organisational advantage which makes it more likely to become a multinational in the first
place.

Section 2 presents the simplest version of the model, in which all union countries are
identical, and there are no union firms. Hence the focus is on when and how a potential
multinational firm will supply the union market: will it export from abroad?; will it establish
branch plants within the union?; and, if the answer to the latter is yes, how many will it
establish? Section 3 extends the analysis to allow for incumbent domestic firms. Now, the
liberalisation of trade between union countries allows improved market access by firms from
partner countries as well as by the foreign multinational. Finally, Section 4 allows for some
degree of heterogeneity between union countries and examines how the conclusions of earlier
sections must be qualified in that case.

2. Exporting vs. FDI

I begin with the simplest framework in which the effects of market integration on the
incentive for inward investment can be examined. The model is partial equilibrium and
abstracts from strategic considerations to focus on the choices facing a single firm located
outside the union.



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