Uncertain Productivity Growth and the Choice between FDI and Export

CESifo Working Paper No. 2773

Uncertain Productivity Growth and the
Choice between FDI and Export

Abstract

The underlying model analyzes the first time foreign market entry decision of a representative
investor who can choose between export and FDI. The model combines the proximity-
concentration trade-off framework with the real option methodology and sheds light on the
effects of productivity growth. On the basis of a Geometric Brownian motion, three different
productivity scenarios are considered (no growth, deterministic growth, uncertain growth) and
opposed to each other. The introduction of productivity growth increases the likeliness of first
time market entry through FDI. If the firm is confronted with uncertain productivity growth,
market entry through FDI increases even further. Uncertainty is identified as a compounding
force for the derived growth effects. The findings contribute to the static general equilibrium
models which neglect intertemporal selection effects.

JEL Code: F17, F21, F23.

Keywords: export, FDI, uncertain productivity growth, real option approach.

Erdal Yalcin

Chair in International Economics

Eberhard Karls University
Nauklerstrasse 47

72074 Tübingen
Germany

[email protected]

July 2009

I would like to thank Wilhelm Kohler who supported my research in ample ways.
Furthermore, I am profoundly indebted to Davide Sala, who provided invaluable comments.
Thanks are due to Philipp Schroder for inviting me to Denmark, where I developed my basic
ideas further. I have benefited from comments of participants on the CESifo Summer Institute
Conference "Operating Uncertainty Using Real Options". In particular, I thank Giuseppe
Bertola and Thomas Gries. I am grateful for CESifo's financial sponsorship.

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