Uncertain Productivity Growth and the Choice between FDI and Export

Uncertain Productivity Growth

Reshaping equation (31) provides

where the wedge in front of the fixed costs is bigger than one, if α > 0. Therefore, in absence
of productivity growth (earlier scenario) the derived condition coincides with the Marshallian
investment rule and no timing problem occurs. On the other hand, for positive productivity
growth rates the investor will postpone his market entry decision (export or FDI) into the future
Ti* although the net payoffs are positive.

For a market entry in Ti* the net present values of both investment modes result as

and are referred to as the option values. Clearly, for α = 0 these value functions become worthless.
Given the two possible investment times (ti = 0, T_i^*) for each market entry strategy the investor
will compare the net investment value Vi(V) — Ii with its corresponding option value Fi(V). By
defining
the two value functions which determine each market entry mode’s optimal timing, result as

Fi(V) = Ai_c V^βc        for  Vi < V_i^*  postpone investment to T_i^*           (34)

Vi (V) — Ii              for  Vi > V_i^*  invest today (t = 0)                   (35)

with i ∈ {E, F},

where the cut-off productivity levels are represented by V_i^* .

The existence of productivity growth (α > 0) has two new effects on the market entry choice of the
investor. Equation (27) demonstrates that the gross present value of both investments increases in
α. In comparison to the previous scenario, the investor is confronted with lower productivity cut-
offs as the net present value functions increase. However, simultaneously growth in productivity
generates an option value represented by (33) which eliminates this effect completely, as the

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