Uncertain Productivity Growth and the Choice between FDI and Export

Uncertain Productivity Growth
low competition country via exports. Based on these equilibrium results it can be concluded that
the prevailing relative cost pattern must lie below the continuous line in panel c) as it depicts the
only range of relative cost constellations for which the export mode represents a relevant entry
mode.

Panel b) in figure 10 illustrates that a higher degree of competition on the alternative foreign
market turns out to be accompanied by two adjustments. The first effect of an increased com-
petition, is a decrease in both productivity cut-offs tf*. Due to the particular cost assumptions
within the proximity-concentration trade-off framework the FDI mode’s cut-off reduction turns
out to be bigger than in the export mode with

∂r_p ∂r_p

—F < —E < 0

∂ν < ∂ν <

Compliant with the general economic intuition, an investor enters the more competitive market
depicted in panel b) at lower productivity levels and therefore, implicitly at an earlier expected
time. However, there exists a second effect which arises in the presence of higher competition.
All value functions in panel b) increase in their convexity but the rise in the FDI mode’s option
value turns out to be stronger than in the export mode with

∂Ff(fl) > ∂Fe(fl)

As a consequence of the disproportionate increase of the FDI mode’s option and investment values
the upper envelope in panel b) is only composed of FDI related functions. Panel c) represents in a
further way the stronger increase of the FDI mode’s option value. The dotted curve represents all
relative cost constellations in country B for which the option values of both market entry modes
are equal. The continuous line represents the same relationship but corresponds to country A.
Technically, a rise in the degree of competition increases the range of relative cost patterns in
panel c) which enforce first time market entry through FDI. In the underlying example the in-
vestor will serve country B through a foreign plant due to the higher competition. The intuition
for this second effect is as follows. Besides an earlier market entry, a higher degree of competition
necessitates a higher productivity in order to survive in the market. Since the marginal costs in
the FDI mode are lower than in the export mode and since their impact on the profits dominate
in the long run, FDI turns out to become more likely the higher the degree of competition.

38

<<   <   37   38   39   40   41   42   43   >   >>