Product Differentiation and the Location of International Production

Abstract

We analyze how product differentiation influences firms' choice between exporting and foreign direct investment. When product specifications are determined endogenously, we show that there is no symmetric solution to the product specification subgame. The cost disadvantage of an exporting firm translates into a disadvantage in product specification. Overseas production is favored if this allows the investing firm to adopt a more aggressive product specification. Our analysis suggests an ambiguous relationship among location, product differentiation, and cost and demand functions, confirmed by the existence of a parameter range for which there is no pure strategy equilibrium in location choice.

Brexit and Foreign Investment in the UK

“…The link between this approach, and the trade‐theory‐based analysis of FDI of Rowthorn () and De Fraja and Norman () was provided by Bergstrand and Egger (), who linked FDI decisions to market size as well as distance, providing justifications for the use of gravity equations to analyse FDI patterns (see for example Barba Navaretti and Venables ()). Omitting uncertainty from this highlights why previous analyses have found no relationship between currency and FDI flows.…”

Quality, distance and trade: A strategic approach

“…The first investigates trade with quality‐differentiated products (see, e.g., Eaton and Kierzkowski ; Shaked and Sutton ; Flam and Helpman ; Motta et al. ; Cabrales and Motta ; Frascatore ; De Fraja and Norman ; Schott ; Hallak ; Choi et al. ; Sutton ).…”

“…Our paper is also related to two other strands of literature. The first investigates trade with quality-differentiated products (see, e.g., Eaton and Kierzkowski 1984;Shaked and Sutton 1984;Flam and Helpman 1987;Motta et al 1997;Cabrales and Motta 2001;Frascatore 2001;De Fraja and Norman 2004;Schott 2004;Hallak 2006;Choi et al 2006;Sutton 2007). A second stream of literature analyses the optimal trade policy under trade with quality-differentiated products, and includes papers such as Herguera et al (2000Herguera et al ( , 2002, Zhou et al (2002), Boccard and Wauthy (2005) and Saggi and Sara (2008).…”

Trade costs and international strategy of firms: The role of endogenous product differentiation

“…Lyons (1984) first proposed a framework incorporating endogenous product differentiation based on Hotelling (1929), but he considers that MNFs pursue cooperative pricing and differentiation to prevent entry of potential competitors. 1 The studies by Motta (1994), Mathieu (1997) and DeFraja and Norman (2004) are also among the exceptions. Motta (1994) focuses on the role of vertical differentiation and trade costs in international trade and investments.…”

“…However, each firm's decision regarding internationalization is subject to the constraint that the firm's product quality is exogenous. Mathieu (1997) and DeFraja and Norman (2004) analyze how product differentiation influences a firm's choice between exporting and producing abroad when consumers have heterogeneous tastes across varieties. However, our analysis is more general because we allow for the possibility that firms may produce more than one variety.…”