Introduction

We have so far considered a closed economy where domestic oligopolists with different marginal costs compete with each other. This chapter extends this analysis to an open economy context in which foreign firms enter the domestic market and compete with domestic oligopolists.

In the case of a closed economy, helping a minor firm reallocates production from the more efficient firms to the minor firm. If the minor firm is very inefficient and hence its surplus per unit of output is much smaller than that of the other firms, the reallocation of production reduces total producers' surplus so much that this reduction dominates an increase in consumers' surplus, causing total surplus to decline. In the case of foreign direct investment, foreign firms repatriate all their profits to their home country. Thus, from the host country's viewpoint, they are firms that make no contribution to domestic producers' surplus even though they may hold a significant share of the market. Thus, one can expect that helping foreign firms to penetrate may well make the host country worse off. This chapter is devoted to the analysis of this property.

Foreign penetration through direct investment has been a significant issue for a long time in many countries. Direct penetration by big US companies to Europe in various industries since the 1930s aroused widespread fears in European countries, as described in detail by Tugendhat (1971). It has now become a widespread phenomenon all over the world, and the cause of serious international problems.