Uncertain Productivity Growth and the Choice between FDI and Export

Uncertain Productivity Growth

Finally, the optimal expected periodical export cash-flows are given as

∏e (0) = Me ^E

₁ ν _νθ ∖1-Vθ

with Me = Z^{1 νθ} I ----_r I (1 — νθ)

∖ We τ θ )

Transport costs do not accrue in the FDI mode (τ = 1) and expected periodical profits result as⁴

ΠF (tf) = MF tf^κ

νθ

1 fvθ∖ ^1-νθ ,       ₄                 ν

with MF = Z ^1-νθ I — ]    (1 — νθ) and κ =-----.

Cash-flows in both entry modes can be linear, convex, or concave in ^rθ depending on κ. The
following analysis focuses on cases in which the cash-flows are linear or convex in ÿ since this is
a common assumption in recent trade models (Helpman, 2006).⁵

In order to choose the optimal market entry mode, the investor compares both market entry
strategies’ net present investment values which are associated with the earlier explained fixed
costs. The opportunity costs in this certain scenario are equal to the riskless interest rate r and
therefore, net present values of the export and FDI mode result as

Figure 3 depicts the export strategy’s investment value as a continuous line and the FDI mode’s
value as a dotted line.⁶ The two curves’ relative position to each other is not random but enforced
by the proximity-concentration trade-off assumption. As the fixed costs in the export mode are
assumed to be lower than in the FDI mode (comparative fixed cost advantage), for $ = 0 the net
investment value VE — IE will always be higher than VF — IF . Furthermore, due to the higher
variable costs in the export mode a gain in productivity leads to a higher marginal increase in the
FDI investment value (comparative variable cost advantage). Differently expressed, the slope of

The optimal labor demand and output in the FDI mode are LF

Cash-flows will be always linear or convex in ⅛ for κ ≥ 1.

The domestic investment value VD of the plant which serves the investor’s home market is neglected. Implicitly, it
is assumed that VD is not affected by the new foreign market entry.

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