Uncertain Productivity Growth and the Choice between FDI and Export

Uncertain Productivity Growth
an investment. The investment takes place if the discounted profit flows are equal or bigger than
the discounted fixed costs in t (Marshallian rule). The corresponding investment rule results as

Fi(tf) = max[Vi(0,T) - Ii, 0].

On the other hand for a growth rate α > 0 the investor has an incentive to postpone the project
in order to maximize his pay-off, although the current gross value of the cash-flow streams may
be bigger than the current fixed costs. Solving the maximization problem in (28) provides the
optimal investment times for both market entry modes:

For periodical profit flows not too much larger than the user cost of capital rIi , both investment
strategies will be postponed into the future since T_i^* > 0. Due to the proximity-concentration
trade-off assumption the optimal market entry time of exporting clearly differs from the optimal
market entry time of the FDI strategy. For the sake of a better comparability between the
different scenarios it is useful to determine the optimal productivity cut-offs tf * in both investment
strategies. By setting the optimal investment time T_i^* equal to zero it is possible to derive the
investment rule and the optimal cut-off productivity tf* which triggers market entry at t = 0,
respectively. An instantaneous investment in both modes results if

.. M,∙tf^κ               ...          .             .

rI_i = (r — α⁰)------t- = M_itf^κ with i ∈ {E, F}

(r - α⁰)

which states that the investor will execute one of the two investment alternatives if the corre-
sponding cash-flows Mi tf^κ cover their cost of capital use rIi . This optimality condition is known
as the Jorgensonian investment rule (Jorgenson, 1963) and slightly differs from the generally ap-
plied Marshallian rule, which compares the absolute fixed costs with the gross investment values.
By contrast Jorgenson’s rule represents a marginal concept and in the presence of productivity
growth, it leads to an investment rule where fixed costs need not only to be covered by the gross
present value Vi(tf) but by relatively higher values.

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