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Choosing Global Markets
Xiaomin Wu and Xiaopeng Yin
UIBE, China
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Road Map
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1
Introduction
2
Literature Review
3
Modeling and Results
4
Concluding Remarks
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1、Introduction




Motivation:
A. Observation #1:
trade volume/value ↑; & FDI by MNCs ↑ .
→one thing connected above: FDI to build up a “exportplatform” or production base for MNCs→↑or ↓ trade.
 However, the change of production (i.e. Outsourcing) ≠ the
export market change.
 Observation #2:
 Some foreign affiliates of MNCs (results of FDI) and the
headquarters of MNCs supply same market (e.g. Honda factory
in Guangzhou & Japan supply the European market; etc.)
 → Where is the strategic choice for global market, and are
final (export) markets?
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2. Main Literature Review (brief)
 1.Hetrogeneity of firms is shown as the
difference of productivities of firms
currently. Their difference determines
largely whether a firm can entry/stay in a
market, and whether it can be an exporter
(Melitz, 2003; Bernard, Eaton, Jensen &
Kortum, 2005).
2. Not only every firm can export, but the
hetrogeneity (shown as the level of
productivity) will affect/determine the
behavior of exporting for a firm (Helpman,
Melitz和Yeaple; 2004）
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2. Main Literature Review (brief)
 3. Among factors, entry cost and heterogeneity
(Bernard & Jensen, 2001), or fixed cost of exporting
and hetrogeneity (Helpman, Melitz & Yeaple; 2004),
heterogeneityes for a firm’s decision of exporting
 4. From (Melitz , 2003; Helpman, Melitz & Yeaple; 2004),
the main conclusion is: lowest productivity firm will
quit from the market, the high one will stay; the
higher one will sell in the foreign market, the highest
one will do FDI , rather than direct exporting.
 5. Empirical evidence: for the data of foreign
affiliates in China between 1998-2005, Higher
productivity firm will export, and lower on will sell in
the local market (Lu, Lu & Tao; 2010) (i.e. LLT model,
hereafter).
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2. Main Literature Review (brief)
focus
Where are final
markets for
MNCs, which
establish
foreign
affiliates to
produce their
products?
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Are there any
constraints/co
nditions to
restrict/change
the firm’s
behavior for
markets
choosing?
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3. Model
 Model——2×2×1 model (Melitz , 2003):
 Adopting LLT model (with no skilled labor
and no R&D, as Melitz , 2003)
(1) 2 countries：a developed country, say,
America (A), and a developing country, say,
China (C)
（2）2 sectors：the large one produces
homogenous good A, CTR; and the small
one produces hoterogenous good Y, ITR,
facing the monopolistic market
（3）1 input：general and homogenous labor
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3. Theoretical Model
 Variables
i
y
（1） : consumption level on the heterogeneous
good for Country i
  1 /(1  )  1
（2）CES:
（3）E i: total consumption level for Country i ，
（4）P i: price for the heterogeneous good for
Country i
（5）Variable cost per unit: c i / 
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3. Theoretical Model
 Model setting
（6）For a firm: while entry the heterogeneous
good sector: facing a fixed cost to
establishing the factory f mi
（7）During the process of sale: if both
production and sale have been completed
within same country, the fixed cost for sale of
the firm is: f s ;
if both production and sale
have been completed in two countries, the
fixed cost for sale of the firm is f s  f s
（8）Transportation cost: t
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3. Theoretical Model
 Model setting
Demand function for any
heterogeneous good Y is:
y 
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
1
i
1
i 1
E (P )
,0    1
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3. Theoretical Model
 Solving Model
A
p

c
/ 
∵ local price for good Y is:
A

（1）Profit selling in Country
A is: D

A
A
A
1  ( f A  f )


(
1


)
E
c
/

D =
m
s
（2）(Additional) Profit selling in Country
C

C is X

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C
X
= (1   ) E
C
tc /  
A

1
 ( f s  f s )
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3. Theoretical Model
 Solving Model
（3） When the firm does FDI: if the produce good sell
in Country C only, then the additional profit is:
C
I





1
 ( f  fs )
= (1  ) E c /
（4） When the firm does FDI: if the produce good sell
in Country A only, then the additional profit is:
A

C
I
A
I
=
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C
C
 

1
C
m
I
(1   )E tc /   ( f  f s  f s )
A
C
C
m
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3. Theoretical Model
 Solving Model
（3）When the firm does FDI: if the produce good
sell in both Country A and C, the fixed cost to
establish the foreign affiliates has been counted
once. Then the additional profit is:  AC
I


 
AC =  IC+ IA+ f mC =

C
C
A
C
1
1


(1   ) c /  E  E t   ( f m  2 f s  f s )
I
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 


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3. Theoretical Model
 Solving Model
To simplify all function forms,



let    1- ，
C  c 1 , T  t 1 ，Then 5
functions above will be：
(1   ) E
A
  ( f m  f s )，
（1） 
A
C
A
A
D
C
E
(1   )
C
T   ( f  f )


（2） X
s
s ，
A
C
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3. Theoretical Model
 Solving Model
(1   ) E
C




(
f
m  fs )
C
（3）
C
C
C
I
（4）  A
I
EA
(1   )
T   ( f C  f  f )

m
s
s
CC
A
（5） AC
I
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E
(1   )( E  )
T   ( f C  2 f  f )

m
s
s
C
C
C
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3. Theoretical Model
 Additional Assumptions:
（1）TC C  C A
f mA  f s
f mC  f s
f mA  f mC  f s
（2）
E /T  E
A
f mA  f mC  f s  f s
C
E A EC  E A /T

A
C
CC
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3. Theoretical Model
 Assumptions:
（3） f A  f T ( f  f
m
E
s
A

s
s
)
EC
f s C A ( E A  TE C )
 A A
C
fm
E C  ECCC
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C C T ( f s  f s )

A
C
f mC  f s
fs
TE C
 A
f s  f s
E
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3. Theoretical Model
Let F express vertical intercepts of
profit functions, thus
F  F  FI  F  FI
C
X
C
I
A
A
D
AC
Let  express slopes of profit functions,
thus
    
C
X
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C
I
A
I
AC
I
A
D
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3. Theoretical Model
(1) Intersection of Profit  D & productivity  is 1
A
C A ( f mA  f s )
1 
E A (1   )
C

 (2) Intersection of Profit X & productivity  is  2
C AT ( f s  f s )
2 
E C (1   )
C
C

X
 (3) Intersection of Profit
& Profit  I is  3
TC AC C ( f mC  f s )
3  C
E (1   )(TC A  C C )
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3. Theoretical Model
(4) Intersection of Profit  IC & Profit  IA is 
4
f s C
4 
A
C
(1   )( E / T  E )
C
(5) Intersection of Profit

A
I
& Profit

AC is
I
5
f sC C
5 
(1   ) E C
1 <  2<  3 <  4 <  5
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 (.,.,.,.)
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4. Concluding Remarks
 Notes：We use (4 choices) to indicate a American firm’s
strategic choices：
 1st item: if the firm produces and sell in the US: A;
 2nd item: if the firm export (sell) to China: using C; if not,
using 0；
 3rd item: if the firm does FDI in China: using C; if not,
using 0 ；
 4th item: For the case of FDI in China: if sell in China,
using C;
 if sell in the US, using A; if sell both in China and the US,
using AC
 From assumptions from Melitz model (Melitz, 2003;
Helpman, Melitz, &Yeaple, 2004)，the direct exporting
and FDI should be not occur simultaneously. So if the
2nd item is C, the 4th item should be 0.
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4. Concluding Remarks
Finding 1：
When the productivity increases, the
firm will serve both domestic and
foreign markets. And the higher
productivity is, the more incentive to
serve the foreign market. The existing
conclusions from Melitz (2003) and
Helpman, Melitz, &Yeaple (2004) and
others held here.
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 Finding 2，
 When the firm choose
to FDI due to its high
productivity, if there is
any other constraint
such as production
capacity constraint or
financial constraint, the
firm optimal choice for
global marketing will be
shown according to its
productivity order (from
high to low):
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 ( A, O, C , AC )
 ( A, O, C , C )
 ( A, C , O, O)
 ( A, O, O, O)
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4. Concluding Remarks
 Finding 3，
 When the firm choose
to FDI due to its high
productivity, if there is
no any other constraint,
the firm optimal choice
for global marketing will
be shown according to
its productivity order
(from high to low):
 This can explain both
facts observed by Melitz
etc, and LLT, without
introducing R&D and
intermediate goods.
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 ( A, O, C , A)
 ( A, O, C , C )
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