Uncertain Productivity Growth and the Choice between FDI and Export

Uncertain Productivity Growth

VF - IF will always be steeper than the slope of VE - IE . As a result, the export value function
crosses the FDI value function always from above as depict in figure 3. In the underlying example,
an investor will serve the new foreign market through FDI if the prevailing productivity level is
larger than tfF_c1 and for a productivity level between tfE_c and ∣)F_c exporting turns out to be the
optimal market entry strategy. For the remaining productivity range, market entry implies losses
in both modes and is therefore discarded.

Figure 3: Investment Values within the Proximity-Concentration Trade-Off

A decisive aspect whether the FDI strategy dominates the export mode or vice versa depends on
the rank of the productivity cut-offs which result from equation (18) and (19) as

^tfEc = rM^{r and} '■ = ;I                            (²⁰)

Figure 3 illustratively depicts a case in which the intersection between the two value functions
takes place above the horizontal-axes. However, for a cost structure with export fixed costs IE
close to FDI fixed costs, the two value functions may intersect on or below the horizontal axes.
In such a case, only the FDI strategy provides relevant zero or positive net present values and it
would represent the upper envelope function in figure 3. Simultaneously, its cut-off productivity

12

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