Export versus FDI: Learning through propinquity

This paper considers the strategic role learning plays on the choice between FDI and export under demand and cost uncertainty. FDI allows a foreign firm to learn local demand, which is beneficial. However, as it buys inputs from the same local input markets as the rival home firm, two firms’ costs become perfectly correlated, which we prove harmful to the foreign firm. Thus, the interplay of the demand acquisition and the cost correlation effect affects FDI decisions. We show that FDI is more likely to occur when firms produce more differentiated goods and that FDI almost always reduces host country welfare.