Exporting, Licensing, FDI and Productivity Choice: Theory and Evidence from Chilean Data*

This paper develops a trade model in which two heterogeneous firms located in two different countries make their productivity choices by choosing their optimal R&D investment levels and then make a mode choice between exporting, licensing and FDI under Cournot competition in an open economy. The ex-ante difference in the cost efficiency of two firms will lead to difference combinations of ex-post productivity difference and mode choice. A small ex-ante difference ends up with the choice of licensing and zero ex-post productivity difference; an intermediate ex-ante difference leads to the combination of exporting and an enlarged ex-post productivity difference; a large ex-ante difference brings the choice of FDI and an even larger ex-post productivity difference. Besides the ex-ante productivity effect, the model also shows how the difference in market demand sizes of two countries causes different preference among mode choices. I test two sets of theoretical hypotheses developed in this paper by using Chilean firm-level panel data from 2001 to 2007. These are how different mode choices are associated with different productivity levels and market shares and how the productivity difference between more productive foreign plants and less productive domestic plants affects the optimal mode choice decision. The empirical results are consistent with the model predictions.