Exporting versus Foreign Direct Investment: Learning Through Propinquity

Abstract

This paper considers the strategic role learning plays on foreign direct investments (FDI) under demand and cost uncertainty. FDI allows a foreign firm to respond more effectively to changing local demand than if it exports. With cost uncertainty, however, FDI has a second effect. Since a foreign firm procures inputs locally as does its home country rival, the problem of learning is transformed from about its private parameter to about the common parameter, which proves harmful in both price and quantity competition. We show that FDI decisions depend on whether the firm faces relatively more demand or cost uncertainty, how differentiated the rival's product is, and to what extent inputs are locally procured.

Rules of origin and uncertain compliance cost

“…In short, to meet the ROO, firms must flexibly adjust their production processes by replacing incumbent suppliers outside the FTA with entrant FTA suppliers and making these entrant FTA suppliers their trading partners. 4 This adjustment increases the uncertainty surrounding the ROO complier's production cost. 5 For example, when firms switch trading partners, they face the danger of choosing undesirable suppliers that provide low-quality inputs (Tang and Rai 2014;Wagner and Friedl 2007).…”

“…See, for example, Krishna and Krueger (1995), Lopez-de-Silanes, Markusen, and Rutherford (1996), Krueger (1999), Rosellón (2000), Falvey and Reed (2002), Ju and Krishna (2005), and Takauchi (2010Takauchi ( , 2011Takauchi ( , 2014. 4 This type of production adjustment is called "partnering flexibility" (Tang and Rai 2014). 5 Tang and Rai (2014) empirically show that adopting "partnering flexibility" increases performance risk for firms.…”

Export versus FDI: Learning through propinquity

“… + This paper is based in part on our earlier working paper (Creane and Miyagiwa 2007). We thank the anonymous referee for helpful suggestions for revision.…”