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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 by 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.

Suggested Citation

  • Marc-Andreas Muendler, 2014. "Export or merge? Proximity vs. concentration in product space," Asia-Pacific Journal of Accounting & Economics, Taylor & Francis Journals, vol. 21(1), pages 35-57, March.
  • Handle: RePEc:taf:raaexx:v:21:y:2014:i:1:p:35-57
    DOI: 10.1080/16081625.2014.874939
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    More about this item

    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • L12 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Monopoly; Monopolization Strategies
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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