Uncertain Productivity Growth and the Choice between FDI and Export

Uncertain Productivity Growth

investment rule provides the productivity cut-offs for both market entry modes as

The difference between the interest rate r and the productivity growth rate α⁰ represents the real
opportunity cost rate δc . For a low productivity growth rate the opportunity costs of delaying
each investment are high, whereas a high growth rate affects δ_c⁰ negatively.

In the illustrative example in figure 5 exporting is in principle profitable for a current productivity
level between tf⁰E and tfE if it is started instantaneously (t=0) but by starting in TE the net present
profits represented by the option value FE (tf) are higher. Therefore, exporting is postponed until
the current productivity level reaches tfE at which the investor is indifferent between postponing
and investing into the export platform. Consequently, as long as there is a positive difference
between the option value Fi (tf) and the net present value Vi(tf) -Ii there exists a value of waiting
and the market entry is postponed into Ti*. Due to the same reasoning, for productivity levels
between tf⁰F and ∣Γ_f, the investor postpones his FDI investment decision into TF, although an
immediate market entry would provide profits. Graphically expressed, it is the upper envelope
function in figure 5 which determines the final optimal market entry mode.

Generally, the determination of the optimal market entry mode necessitates the consideration
of two aspects. First, the investor needs again to determine the ordinal rank between the two
productivity cut-offs.

It can be shown that the cut-offs’ rank depends on the different cost structures with

νθ

¾ Q 1 if Ie Q
¹¹ _f             If

which is the same result as in scenario one.

The conclusion from this equivalent results is that the introduction of growth into the proximity-
concentration trade-off framework does not change the relationship between the productivity
cut-offs compared to the previous scenario. Figure 6 depicts the earlier introduced relative unit
cost box within the proximity-concentration trade-off framework. The rank of the productivity
cut-offs for all possible relative cost constellations is the same as in figure 4.

In order to derive the optimal market entry strategy, it is necessary to determine how the two

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