Outsiders' Response to Europe 1992: Theoretical Considerations and Empirical Evidence

This paper examines the response to the creation of the European Union by firms located outside the European Community that seek to serve its markets. Analysis of some of the major steps taken by the European Community to complete the internal market shows that the relative competitive position of outsiders is expected to deteriorate, even if the concept of “Fortress Europe” is rejected by the Community. Outsider firms can neutralize some of the disadvantages they encounter by engaging in foreign direct investment in the European Community which transforms them, in some sense, into insiders. This paper outlines a model that distinguishes between the expected investment behavior of producers of different kinds of goods. Distinction is made between Heckscher-Ohlin goods (H-goods), characterized by publicly available technologies, and Schumpeter goods (S-goods), based on firm-specific knowledge. Analysis of recent foreign direct investment by Israeli firms in the European Community and in other parts of the world shows that patterns of actual flows by sector, by geographic region and over time, correspond to predictions derived from the model.