Export, foreign direct investment, and local content requirement

Local content requirement (LCR) is a popular government policy in developing countries to regulate foreign direct investment. We establish a model with heterogeneous multinational firms and show that (a) the LCR policy affects the firms' modes of entry to a new market, with FDI being more likely to be adopted when there are lower LCRs, and (b) when facing the same LCR, a less efficient firm is more likely than a more efficient firm to adopt the FDI mode. Furthermore, we investigate the design of an optimal LCR policy. Two types of FDI benefits are considered, and two types of LCR policy are compared.