Foreign Direct Investment Versus Exports: How Multinational Firms Decide On The Ideal Production Strategy For Overseas Markets

Should multinational firms looking to sell into an overseas market do so by exporting goods to that country or by foreign direct investment, building a factory in the target country and selling the output there? Research by Arijit Mukherjee, published in the October 2009 issue of the Economic Journal, suggests that when the firm faces
labour unions, it should enter the market by both exporting and foreign direct investment.

The study suggests that exports and foreign direct investment are not necessarily substitutes, and that different markets require a different mix of exports and foreign direct investment.

A monopolist multinational may be better off by both exporting and undertaking foreign direct investment if the product market is large enough.

Competition in the product market reduces the multinational”s incentive for serving the product market through both exporting and foreign direct investment. But if the product market is neither very small nor very large, a combination is the best option.

The driver of these results is the presence of trade unions. If the labour market is unionised, the multinational firm may need to consider the effect on wages caused by its choice of plant location.

Operating multiple plants helps the multinational to ”soften” the effect on wages and hence it benefits from operating multiple plants. For example, if the production level affects only the wage rate in the foreign market, a certain amount of exporting to the foreign market helps to reduce the wage rate in the foreign country.

Hence, the trade-off between the cost of exporting and the benefit of wage reduction determines the best production strategy of the multinational.

”Unionised Labour Market and Strategic Production Decision of a Multinational” by Arijit Mukherjee is published in the October 2008 issue of the Economic Journal.

Arijit Mukherjee

University of Nottingham | 0115 951 4733 | arijit.mukherjee@nottingham.ac.uk