Chawla, Arunish
(2008)
Firm level effects of foreign investment policy.
PhD thesis, London School of Economics and Political Science.
Abstract
In this thesis I investigate how the FDI Policy environment affects certain aspects of firm behaviour. First, I introduce the option value of foreign direct investment into a framework of Dixit-Stiglitz type monopolistic competition. Starting from a pure trading equilibrium and solving for the optimal foreign investment rule gives a scale-up factor, which implies existence of a wedge between mark-up revenues and foreign investment costs. Greater volatility and risk aversion increase this scale-up over foreign investment costs implying a delay in the exercise of FDI option. The model is extended to include a Poisson jump process, which has policy implications for FDI reforms. This model explains 'wait and watch' behaviour of multinational firms better than a pure comparative advantage-trade cost framework does. Second, I develop a model of firm heterogeneity with market power. Mark-ups are endogenous and responsive to toughness of market competition. It brings out potential gains in market power and profits as an additional reason for undertaking FDI in addition to reasons already enshrined in the literature as proximity-concentration trade-off. The model is used to analyse the interaction between profit maximizing behaviour of multinational firms and the welfare maximizing objective of the central planner. FDI is not an unambiguously welfare improving proposition. While multinational firms gain profits, host and home country may gain or lose welfare depending on how returns from foreign investment are distributed among the residents of the home and the host economies. Third, I analyse the relationship between foreign investment policy and manufacturing firms' performance as estimated by multi-factor productivity against the backdrop of Indian liberalisation of the 1990's. Using a firm-year panel from 1989 to 2004, I obtain consistent estimates of firm's production functions and controlling for industrial delicensing and trade reforms, estimate the effect of foreign investment policy on measured productivity of manufacturing firms. I find liberalisation of foreign investment regime has significantly improved manufacturing firms' performance in India over this period. A particularly interesting feature of India's foreign investment regime has been encouraging adoption of foreign technology by domestic firms, while at the same time opening up these industry sectors to foreign direct investment. These two elements of the foreign investment regime have actually been complementary to each other.
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