Uncertain Productivity Growth and the Choice between FDI and Export

Uncertain Productivity Growth
with a stronger focus on multinational enterprises emerged in the 1980s. Besides the attempt to
explain more complex export patterns, FDI started to be implemented into the new theoretical
frameworks. Among them are Horstman and Markusen (1987), Markusen and Venables (1998,
2000), Brainard (1993), Helpman (1984, 1985), Ethier and Markusen (1996), and Ehtier (1986).
A common ground within these models is the elaboration of the relationship between fixed and
variable costs as one fundamental determinant, whether a firm starts to export or becomes a for-
eign direct investor (horizontal FDI). One specific assumption about the cost structure of firms
and the resulting international firm behavior has been summarized as the proximity-concentration
trade-off framework (Brainard 1993, 1997). Within this framework, firms are considered to be
confronted with higher fixed costs in the FDI mode relative to the export mode, if they intend
to enter a new market. Due to the fixed costs, firms possess increasing returns to scale in both
market entry strategies. Simultaneously the export mode is assumed to exhibit higher variable
costs relative to the FDI strategy since transport costs and other barriers add to the domestic
production costs. As a result, the extent of scale effects in the two entry modes differ with re-
spect to the state variables (quantity, goods price, productivity etc.). A strong significance of the
proximity-concentration trade-off framework has been depicted empirically by Brainard (1997)
for 27 countries on the industry level. Since then, the proximity-concentration hypothesis, as it
is also referred to, has been established as a workhorse which explains export and FDI patterns.
The latest theoretical breakthrough in explaining the international firm behavior has been achieved
by the so called New New Trade Theories, based on the seminal work of Melitz (2003), which was
extended by Helpman et al. in 2004. Since empirical studies from the 1990s (Bernhard and Jensen,
1995; Doms and Jensen, 1998) and subsequently point out that differences in firm productivity
lead to a firm distribution within an industry, in which not all firms export or become foreign
direct investors (Greenaway and Kneller, 2007), the New Trade Theory appears to be limited for
deeper explanation. Helpman et al. (2004) give consideration to these new empirical insights
by introducing firm heterogeneity within an industry. The authors overcome the limitation of
the standard monopolistic competition models (symmetric firms within a sector) by introducing
the proximity-concentration hypothesis and by implementing productivity uncertainty. Figure
1 demonstrates the common result of this literature strand in which the most productive firms
within a sector will be foreign direct investors, less productive ones will export and the least
productive ones will serve only the home market conditional on survival. The sector-specific firm

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