DP4041 Distance and FDI When Contracts are Incomplete

Author(s): Gianmarco Ottaviano, Alessandro Antonio Turrini
Publication Date: September 2003
Keyword(s): foreign direct investment, incomplete contracts, trade costs
JEL(s): F23
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=4041

We introduce incomplete outsourcing contracts in an otherwise standard model of MNEs based on the trade-off between proximity and concentration. This has implications for the choice between export and FDI and the way this is affected by the distance between source and host countries. In particular, incomplete outsourcing contracts can account for the observed emergence of FDIs in large markets not only when trade costs are large but also when trade costs are small. Moreover, contractual incompleteness alters someway dramatically the choice of supply mode made when contracts are complete.