Foreign direct investment under monopolistic competition

Foreign direct investment under monopolistic competition: Theory

Foreign direct investment under monopolistic competition: Empirical Evidence

Foreign direct investment under monopolistic competition: Policy Issues

Central questions in the study of foreign direct investment (FDI) are:Where do firms choose to locate their production? To what extent do firms become multinational and supply foreign markets through production by local subsidiaries rather than through trade? What are the associated levels of FDI and patterns of trade? Theories of FDI under monopolistic competition provide a framework to address these questions.They analyzefirms’ choices onwhere to locate production, and also endogenize the number of active firms operating in each country.

Monopolistic competitionmodels typically focus on horizontal rather than vertical FDI. That is, they look at situations where FDI involves producing the same good (or at least undertaking the same stage of production) in several locations.This is in contrast to verticalFDI, where FDI takes the form of offshoring different parts of the production process, although a monopolistic competition framework has also been used to address this issue (for example, Helpman and Krugman 1985).

See also factor endowments and foreign direct investment; fixed costs and foreign direct investment; foreign direct investment and exit of local firms; foreign direct investment: the OLI framework; foreign direct investment under oligopoly; knowledge-capital model of the multinational enterprise; market size and foreign direct investment; monopolistic competition; outsourcing/offshoring; trade costs and foreign direct investment; vertical versus horizontal foreign direct investment

FURTHER READING

• Barba Navaretti, Giorgio, Anthony J. Venables, Frank G. Barry, Karolina Ekholm, Anna M. Falzoni, Jan I. Haa land, Karen Helene Midelfart, and Alessandro Turrini. 2004. Multinational Firms in the World Economy. Princeton, NJ: Princeton University Press. Recent re view of theory and empirical literature on FDI and multinational firms. 
• Brainard, S. Lael. 1997. ‘‘An Empirical Assessment of the Proximity concentration Trade off between Multi national Sales and Trade.’’American Economic Review 87 (4): 520 44. Finds that sales by overseas affiliates of multinationals relative to exports increase with high trade costs, low investment barriers, plant level scale economies, and more similar countries.
•  Dixit, Avinash K., and Joseph E. Stiglitz. 1977. ‘‘Monop olistic Competition and Optimum Product Diversity.’’ American Economic Review 67 (3): 297 308. The workhorse model of monopolistic competition. 
• Helpman, Elhanan, and Paul R. Krugman. 1985. Market Structure and Foreign Trade. Cambridge MA: MIT Press. A monograph on trade under imperfect compe tition. 
• Helpman, Elhanan, Marc J. Melitz, and Stephen R. Yeaple. 2004. ‘‘Export versus FDI with Heterogeneous Firms.’’ American Economic Review 94 (1): 300 16.Employs the heterogeneous firmmodel to FDI and demonstrates the coexistence of firms that export and firms that under take FDI. 
• Markusen, James R., and Anthony J. Venables. 1999. ‘‘Foreign Direct Investment as a Catalyst for Industrial Development.’’ European Economic Review 43 (2): 335 56. Model of the effect of FDI on local firms that
•  highlights how the profits of local firms can increase due to reduced input costs stemming from linkages to sup pliers of intermediates. 
• . 2000. ‘‘The Theory of Endowment, Intraindustry and Multinational Trade.’’ Journal of International Economics 52 (2): 209 34. Model demonstrating that multinationals are more likely to form when countries are more similar in terms of their relative (and absolute) endowments, as the data indicates is the case. 
• Rodriguez Clare, Andres. 1996. ‘‘Multinationals, Linkages, and Economic Development.’’ American Economic Re view 86 (4): 852 73. Model examining the conditions needed for linkage effects fromFDI on the host country to be favorable. 

ANTHONY J. VENABLES