Foreign Direct Investment and Exports with Growing Demand

57 Pages Posted: 15 May 2001

See all articles by Rafael Rob

Rafael Rob

University of Pennsylvania - Department of Economics

Nikolaos Vettas

Athens University of Economics and Business - Department of Economics; National Kapodistrian University of Athens - Faculty of Economics; Centre for Economic Policy Research (CEPR)

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Date Written: May 2001

Abstract

We explore entry into a foreign market with uncertain demand growth. Amultinational can serve the foreign demand in two ways, or by a combinationthereof: it can export its product, or it can create productive capacity viaforeign direct investment. The advantage of FDI is that it allows lower marginalcost than exports. The disadvantage is that FDI is irreversible and, hence,entails the risk of creating under-utilized capacity in case the market turns outto be smaller than expected. The presence of demand uncertainty andirreversibility gives rise to an interior solution, whereby the multinational does- under certain conditions - both exports and FDI. We argue that this featureis consistent with observed behaviour of multinationals, yet it has not arisen inprevious theoretical formulations.

Keywords: Entry, exports, foreign direct investment, investment underuncertainty, new markets

JEL Classification: D80, D92, F20

Suggested Citation

Rob, Rafael and Vettas, Nikolaos, Foreign Direct Investment and Exports with Growing Demand (May 2001). Available at SSRN: https://ssrn.com/abstract=270110

Rafael Rob (Contact Author)

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States
215-898-6775 (Phone)
215-573-2057 (Fax)

Nikolaos Vettas

Athens University of Economics and Business - Department of Economics ( email )

76 Patission Street
GR-10434 Athens
Greece
+30 210 8203179 (Phone)

National Kapodistrian University of Athens - Faculty of Economics ( email )

8 Pesmazoglou street
GR-10559 Athens
Greece
+30 210 8203179 (Phone)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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