Uncertain Productivity Growth and the Choice between FDI and Export

Uncertain Productivity Growth

Relative Cost Structures in Area C₁ :

All relative cost patterns above the diagonal line, declared as area C1, will lead to a FDI pro-
ductivity cut-off ^*F which is always smaller than the export cut-off ∣)ⁱE. Simultaneously, the FDI
mode’s option function will always be higher than the export mode’s one with

Ff (0) > Fe(0) and ^F < ¾.                         (39)

Therefore, in figure 5 the upper envelope function is always represented either through the FDI’s
option or net present value function. Consequently, for all these cost constellations an investor
will unambiguously serve the foreign market through FDI, conditional on market entry.

Relative Cost Structures in Area C₂ :

For cost constellations in area C2 the relation between the two option functions and productivity
cut-offs is given by

Ff (tf) < Fe (tf) and ^F > ¾.                           (40)

For these cost patterns figure 5 would map an upper envelope function consisting of all four avail-
able value functions. Depending on the current state of the productivity level the investor enters
the market either through exports or FDI. Therefore, area C2 does not lead to an unambiguous
market entry strategy.

Relative Cost Structures in Area C₃ :

Relative cost structures between the diagonal line and above the dash line are declared as area
C3 and lead to a formation of the option value functions and productivity cut-offs with

Ff (tf) > Fe (tf) and &*_F < ¾.                           (41)

For these constellations the investor is in principle willed to enter the new foreign market through
exports at lower productivity levels relative to the FDI mode. However, as the option value of the
FDI mode is always higher than the two export value functions, exporting is always neglected for
the sake of FDI. Figure 5 illustratively represents such a cost constellation and it can be shown

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