FDI versus Exporting under Cournot oligopoly and trade in a hotelling model of differentiated duopoly

This study investigates FDI versus export decisions under oligopoly in the trade liberalization, and examines how trade liberalization affects welfares in the Hotelling model of differentiated Bertrand duopoly. It uses a four-firm two-country Cournot oligopoly model to resolve the conflict between the theory, which predicts that a reduction in trade costs discourages FDI, and the empirical evidence, which is that trade liberalisation has led to an increase in FDI, and shows that both FDI and exporting can co-exist in the same market, in line with recent trends. In the static game, a reduction in trade costs causes a decrease in FDI, and the outcomes are often a prisoners’ dilemma where the firms are worse off when they all undertake FDI than when all firms from both markets choose to export. To avoid it, firms can tacitly collude over their FDI versus export decisions when the game is infinitely-repeated. Then a reduction in trade costs may lead firms to switch from exporting to undertaking FDI when trade costs are sufficiently high. The robustness of the analysis is checked by using the constant elasticity demand function. A two-country Hotelling model of spartial duopoly is developed to consider the welfare effects of trade liberalisation. It is shown that gains from trade occur when products are highly differentiated, and losses from trade occur when products are close substitutes, as the positive effect of more product choices overweighs the negative effect of the decreased home sales caused by trade liberalization when products are highly differentiated. This contrasts to Fujiwara (2009) who prove that there are always losses from trade in the Hotelling model. The reason behind is that the kinked demand market structure is often ignored, and by considering the full features of the Hotelling model, welfare effects depend on product differentiation and trade costs.