Investment liberalisation and firm selection process: A welfare analysis from a host-country perspective

This paper analyses the welfare and market structure effects of investment liberalisation allowing for intra-industry firm-heterogeneity to account explicitly for the firm selection process induced by foreign firm entry and its interactions with productivity spillovers. Using a two-stage oligopolistic model in which a foreign firm decides whether and how to enter the host-country market (export versus foreign direct investment) while two asymmetrical local firms decide on their exit/stay strategy, it is shown that even where productivity spillover effects are absent and the entry of the multinational firm leads to the crowding-out of local firms, foreign direct investment can still improve host-country welfare.