Abstract/Summary

Cross-flows of FDI occur when firms invest in each other’s home countries, affecting the terms of competition in each market. They are explained by internalisation theory but have never been comprehensively investigated. This paper models cross investment in a duopoly with differentiated products. The firms decide whether to enter each market and whether to serve it through trade or local production. The model combines firm, country, and industry-level factors. It places cross investment in the wider context of cross sourcing, including cross trading and asymmetric sourcing. It reveals different forms of cross investment, rather than being limited to cross multi-domestic. Overall, cross investment is favoured by highly differentiated products, low comparative advantage, large markets, high trade costs and low costs of FDI.