Foreign Direct Investment and Technology Transfer Under Uncertainty in a Liberalizing Host Economy

This paper tackles the issue of investment and optimal “choice” of market structure for a foreign multinational enterprise (MNE) in a newly liberalized economy under uncertainty and in the presence of sunk costs. A minimalist duopolistic model is developed whereby a foreign investor's subjective belief about the probability distribution of policy uncertainty is endogenized as a function of the aggregate output in the tradable goods sector. The main propositions derived from the model are consistent with some unconventional empirical findings in the literature on Foreign Direct Investment (FDI), technology transfer to and crowding out of domestic firms in LDEs.