Foreign Fast Seconds and Market Contestability in Emergin Economies: Implications for Domestic Welfare

Emerging markets economies often present profitable opportunities for entry by large mutinational firms domiciled in developed economies. Such entry has the potential to bring important gains to the emerging economy consumers as well. Yet at the same time, such foreign direct investment (FDI) also poses a risk in that it will typically induce exit by domestic firms. In turn, this can result in not only the loss of profit from such firms but also lead to increased concentration and less competition with additional adverse consequences for domestic consumers. Theoretical models that investigate this possibility include Ono (1990), Richardson (1998), and Bjorvatn (2000). The question has also motivated empirical work on specific non-tradable markets in which FDI has focused, most notably, the banking sector where the introduction of large scale FDI has typically been followed by domestic firm exit and substantially increased concentration in Latin America and Central Europe. These include studies by Clarke, Cull, and Martinez Peria (2001) and Gelos and Roldos (2002), and Mkrtchyan (2005). While these studies generally find that increased concentration has been associated with price-cost margins, this is not quite the same as a determination of the impact of such entry on domestic welfare.