Endogenous FDI Spillovers with Spillover-Prevention Costs

This paper aims to explore the role of spillovers in the strategic choice for a MNE in a duopoly model, especially focusing on endogenous FDI spillovers with spillover-prevention costs. After discussing the exogenous spillover case, this paper shows that with a quadratic spillover-prevention cost function, the FDI-performing firm may choose a positive level of spillovers, which is lower than the exogenous level, and also shows how endogenizing spillovers affect the home firm’s decision on plant location. As extensions of the model, this paper explores a n-FDI-performing firm case and a m-FDI-host-country firm case separately. In the m-FDI-host-country firm case, numerical examples show that the spillover-prevention cost is an important factor and that the effects of the number of FDI host country firms on the level of spillovers and the cutoff value of trade cost are not always monotonic. An welfare analysis shows that in the duopoly case, endogenizing spillovers shift down the range of trade cost where both the home firm and the foreign country prefer FDI. JEL Classification: F12, F23, O33.