Foreign Production, Strategic Choice and the Domestic Market Effect

Published on Oct 1, 2000
This paper presents a simple model of the interaction between two firms, based in different countries, each of which faces the export v MNE choice concerning the serving of each other’s home market. The basic game structure is similar to that elsewhere in the literature (Horstmann & Markusen (1992), and Rowthorn (1992)). To this, I add a further choice: investment in a new technology that allows a corporate-wide reduction in variable costs (i.e. cost reducing R&D). In the presence of such corporate-wide investment, the firms’ decisions concerning each other’s home markets are interdependent. Furthermore, strategic motives for foreign direct investment (FDI) relate not only to a firm’s foreign market profits, but also to those from their domestic market. This is because one firm’s export v MNE choice can influence both its rival’s choice and investment behaviour. One possibility is that a firm sets up a plant overseas in order to influence the behaviour of its rival, even though its profits from serving the foreign market would be higher by exporting.
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