Mode of Foreign Entry, Technology Transfer, and FDI Policy

Foreign direct investment (FDI) can take place either through the direct entry of foreign firms or the acquisition of existing domestic firms. The preferences of a foreign firm and the host country government over these two modes of FDI are examined in the presence of costly technology transfer. The trade-off between technology transfer and market competition emerges as a key determinant of preferences. The Paper identifies the circumstances in which the government and foreign firm's choices diverge, and how domestic welfare can be improved by restrictions on FDI which induce the foreign firm to choose the socially preferred mode of entry.