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Foreign Direct Investment and Exports Dynamics with Demand Learning

  • Kotseva, Rossitsa
  • Vettas, Nikolaos
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    We model a firm's choice between exporting and investing in a foreign country in the presence of possibly persistent demand uncertainty. We allow for demand shocks that, while increasing expected profit, impede learning. The firm learns gradually, in a Bayesian fashion, by observing past demand realizations. We derive the optimal exports and investment paths, examine how they depend on the technology parameters and the structure of uncertainty and show that learning alone may explain the S-shape of these paths. Immediate investment is possible despite the presence of demand uncertainty, if there are significant positive demand shocks and learning is likely to take time.

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    Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5262.

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    Date of creation: Oct 2005
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    Handle: RePEc:cpr:ceprdp:5262
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    1. Linda S. Goldberg & Charles D. Kolstad, 1994. "Foreign Direct Investment, Exchange Rate Variability and Demand Uncertainty," NBER Working Papers 4815, National Bureau of Economic Research, Inc.
    2. Motta, Massimo, 1992. "Multinational firms and the tariff-jumping argument : A game theoretic analysis with some unconventional conclusions," European Economic Review, Elsevier, vol. 36(8), pages 1557-1571, December.
    3. Demers, Michel, 1991. "Investment under Uncertainty, Irreversibility and the Arrival of Information over Time," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 333-50, April.
    4. Satya P. Das, 1983. "Multinational Enterprise under Uncertainty," Canadian Journal of Economics, Canadian Economics Association, vol. 16(3), pages 420-28, August.
    5. Schnitzer, Monika, 1999. "Expropriation and control rights: A dynamic model of foreign direct investment," International Journal of Industrial Organization, Elsevier, vol. 17(8), pages 1113-1137, November.
    6. Rob, Rafael, 1991. "Learning and Capacity Expansion under Demand Uncertainty," Review of Economic Studies, Wiley Blackwell, vol. 58(4), pages 655-75, July.
    7. Vettas, Nikolaos, 2000. "Investment Dynamics in Markets with Endogenous Demand," Journal of Industrial Economics, Wiley Blackwell, vol. 48(2), pages 189-203, June.
    8. Buckley, Peter J & Casson, Mark, 1981. "The Optimal Timing of a Foreign Direct Investment," Economic Journal, Royal Economic Society, vol. 91(361), pages 75-87, March.
    9. Hoff, Karla, 1997. "Bayesian learning in an infant industry model," Journal of International Economics, Elsevier, vol. 43(3-4), pages 409-436, November.
    10. George Norman, 1998. "Foreign Direct Investment and International Trade: a Review," Discussion Papers Series, Department of Economics, Tufts University 9810, Department of Economics, Tufts University.
    11. Rafael Rob & Nikolaos Vettas, 2001. "Foreign Direct Investment and Exports with Growing Demand," Penn CARESS Working Papers f8c083d9257897f97ff49d054, Penn Economics Department.
    12. Ignatius J. Horstmann & James R. Markusen, 1995. "Exploring New Markets: Direct Investment, Contractual Relations and the Multinational Enterprise," NBER Working Papers 5029, National Bureau of Economic Research, Inc.
    13. Pietra Rivoli & Eugene Salorio, 1996. "Foreign Direct Investment and Investment under Uncertainty," Journal of International Business Studies, Palgrave Macmillan, vol. 27(2), pages 335-357, June.
    14. Itagaki, Takao, 1991. "A two-step decision model of the multinational enterprise under foreign demand uncertainty," Journal of International Economics, Elsevier, vol. 30(1-2), pages 185-190, February.
    15. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November.
    16. Giovanni Maggi, 1996. "Endogenous Leadership in a New Market," RAND Journal of Economics, The RAND Corporation, vol. 27(4), pages 641-659, Winter.
    17. Bruce Kogut & Nalin Kulatilaka, 1994. "Operating Flexibility, Global Manufacturing, and the Option Value of a Multinational Network," Management Science, INFORMS, vol. 40(1), pages 123-139, January.
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