Investing in Terra Incognita: Waiting and Learning

Abstract

This paper analyzes informational aspects linked with foreign direct investment in economies that just open up to foreign investors and steer towards a market economy. From the viewpoint of foreign firms, such economies are still terra incognita as far as economic and practical conditions for setting up foreign direct investment are concerned. The best way to obtain relevant information is via the experiences from other investment projects. In this situation waiting may be advantageous for the firms, given that sunk costs have to be incurred in connection with investment and the investment decision can be postponed. However, since every investor provides a positive informational externality, this waiting is harmful for the investment process and for the economies themselves. Economic policies to correct the externality problem may thus be justified.

JEL Classification: F21, P21, O23