This paper proposes a proximity-concentration tradeoff in product space as a determinant of horizontal
foreign direct investment (FDI). Firms that enter a foreign market by exporting are able to
capture consumer surplus from introducing a differentiated product with characteristics that the
incumbent cannot match. In relatively globalized product space, in contrast, consumers perceive
an entrant’s difference to existing products as less pronounced, so a consumer’s virtual distance
costs in product space are lower and a merger with an incumbent (horizontal FDI) offers pricing
power that allows the entrant to extract consumer rent. Lower physical trade costs of shipping
make Bertrand price competition fiercer in differentiated product space and can provide an additional
incentive for a merger. A basic product space model with a linear Hotelling setup can
therefore explain why FDI has become more frequent in recent periods in the presence of falling
trade costs. Cross-border merger and acquisitions data support the model’s prediction that horizontal
FDI grows relatively faster than exports in differentiated goods industries, compared to
homogeneous-goods industries