Uncertain Productivity Growth and the Choice between FDI and Export

Uncertain Productivity Growth
that area C3 will always lead to a market entry through FDI, since

(43)

Area C3 evolves for positive growth rates and its extent depends on the size of α. Condition (38)
shows for a decreasing α the exponent βK approaches zero. Consequently, area C₃ diminishes
until the dashed line in figure 5 coincides with the diagonal curve. This result represents the
relative unit cost box for scenario one with α = 0 and confirms the consistency of the framework.
On the contrary, an increase in α enlarges area C3 as the dashed curve in figure 5 becomes more
convex. The economic intuition for this adjustments follows from condition (38). An increase
in productivity growth reduces the comparative fixed cost advantage of the export mode and
implicitly increases the comparative variable cost advantage of the FDI strategy. Differently
expressed, a rise in α increases the FDI mode’s option value stronger than the export option
value. Consequently, as area C1 and C3 unambiguously enforce market entry through FDI it can
be concluded that within the proximity-concentration trade-off framework a rise in α increases
the range of cost patterns which result in FDI.

Result 2:

For IE < IF and wEτθ > wF the availability of productivity growth increases the range of
relative cost constellation which enforce FDI as the optimal market entry strategy. The higher
the growth rate α the larger the share of cost patterns which lead to FDI (far more than 50% ).

Even though the underlying framework only considers a representative firm, the last result has
crucial implications for sectoral first time market entry investments. Accordingly, sectors with
higher productivity growth should exhibit a higher share of FDI as first time entry mode, since
the range of relative cost constellations which promote FDI is relatively larger.

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