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Export or Merge? Proximity vs. Concentration in Product Space

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  • Marc-Andreas Muendler

Abstract

This paper proposes a proximity-concentration tradeoff in product space as a determinant of horizontal foreign direct investment (FDI). Firms that enter a foreign market by exporting are able to capture consumer surplus from introducing a differentiated product with characteristics that the incumbent cannot match. In relatively globalized product space, in contrast, consumers perceive an entrant's difference to existing products as less pronounced, so a consumer's virtual distance costs in product space are lower and a merger with an incumbent (horizontal FDI) offers pricing power that allows the entrant to extract consumer rent. Lower physical trade costs of shipping make Bertrand price competition fiercer in differentiated product space and can provide an additional incentive for a merger. A basic product space model with a linear Hotelling setup can therefore explain why FDI has become more frequent in recent periods in the presence of falling trade costs. Cross-border merger and acquisitions data support the model's prediction that horizontal FDI grows relatively faster than exports in differentiated goods industries, compared to homogeneous-goods industries.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19751.

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Date of creation: Dec 2013
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Handle: RePEc:nbr:nberwo:19751

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  1. Rauch, James E., 1999. "Networks versus markets in international trade," Journal of International Economics, Elsevier, Elsevier, vol. 48(1), pages 7-35, June.
  2. Federico J. Díez & Alan C. Spearot, 2012. "Core competencies, matching, and the structure of foreign direct investment: an update," Working Papers, Federal Reserve Bank of Boston 12-8, Federal Reserve Bank of Boston.
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