Should the Host Economy Invest in a New Industry?

We consider a small open economy with two sectors (an old sector producing a consumption good and a new sector producing a new good), two production factors (physical capital and specific labor), and two heterogeneous firms in the new sector (a multinational firm and a domestic firm). First, our framework highlights that in a poor country with low return of training and weak FDI spillovers, the domestic firm cannot exist in the new industry requiring a high fixed cost. Second, once the host country holds necessary conditions to create a domestic firm, its productivity is the key factor allowing it to enter the new industry, and even eliminate the multinational firm. Interestingly, credit constraint and labor/capital shares play important roles in the competition between firms.