Export Versus FDI in Services

Abstract

In the Helpman et al. model (HMY), costs of transportation shape the decisions of firms about serving foreign customers by exporting or by doing FDI. The analysis of FDI in IT‐related services presents a challenge given the low cost of transportation through telecom networks. This study extends the HMY model by considering uncertainty in product quality. This reverses the ordering of the firms that do FDI. These predictions are tested using Indian data in two industries: chemicals and software. Chemicals represents a conventional setting, and we find that the most productive firms invest abroad. However, in the case of the software industry, where there is uncertainty about product quality and the transportation cost is low, the results are consistent with the predictions of the extended model: less productive firms invest abroad.

Exports, foreign direct investments and productivity: are services firms different?

“…Given that the firms are highly heterogeneous within each group this result that is based on a non-parametric test that compares the whole productivity distributions is more convincing than the result from a comparison of average values of productivity alone using a parametric test. These findings are in line with the implications of the theoretical model for the choice between fdi and exports for services firms by Bhattacharya, Patnaik and Shah (2010) and with the results from their study that uses data for services firms from India.…”

“…To anticipate the most important results it turns out that the productivity pecking order found in numerous studies using data for firms from manufacturing industries does not exist among firms from services industries. In line with the theoretical model and the empirical results for software firms from India provided by Bhattacharya, Patnaik and Shah (2010) there is evidence that firms with fdi are less productive than firms that export.…”

“…5 Bhattacharya, Patnaik and Shah (2010) This paper contributes to the literature by providing the first evidence on the link of productivity and both exports and foreign direct investment in services firms from a highly developed country. It uses unique new data from Germany -one of the leading actors on the world market for services -that merge information from regular surveys and from a one-time special purpose survey performed by the Statistical…”

“…The big picture that emerges from the results of the studies using data for firms from manufacturing industries is well in line with the predictions derived from the theoretical model by Helpman, Meltiz and Yeaple (2004) -firms that serve the home market only are the less productive group, followed by firms that export and by firms that engage in outward foreign direct investment (usually these firms are exporters, too). Bhattacharya, Patnaik and Shah (2010) argue that the productivity pecking order between exporters and firms with fdi differs between firms from manufacturing industries and firms from services industries. They set up a theoretical model in which less productive profit maximising services firms choose fdi and more productive firms choose export as the mode of serving foreign markets.…”

“…4 Second, in contrast with internationally traded goods where all aspects of the product can be tested by the prospective buyer before purchase, in services production where certain aspects of the quality are intrinsic to the producer this is not the case. Bhattacharya, Patnaik and Shah (2010) assume that physical proximity of the provider reduces the risk perception of the customer -the risk perceived by a customer is greater when services are purchased from a foreign company than from a local provider. Hence the probability that a provider realises a positive demand for his service is higher for a firm with fdi than for a firm that exports services from a foreign country.…”