14.581 International Trade
— Lecture 21: Multinationals Theory (I) —
Technological Theories
14.581
Week 12
Fall 2011
14.581 (Week 12)
Multinationals Theory (I)
Fall 2011
1 / 19
Today’s Plan
1
2
3
Horizontal MNEs
Vertical MNEs
Quantitative Models of MNEs
14.581 (Week 12)
Multinationals Theory (I)
Fall 2011
2 / 19
Multinational Enterprises (MNEs)
De…nitions
MNE “An enterprise that controls and manages production establishments
(plants) located in at least two countries. It is simply one subspecies of
multiplant …rms”; Caves (1996)
The trade literature distinguishes between two broad types of MNEs:
1
2
Horizontal MNE
Because of trade costs, …rms duplicate production
facilities and sell locally in two or more markets (Toyota, Nestle)
Vertical MNE
Because of factor price di¤erences, …rm locates its
headquarter in one country but does production in another (Nike, Intel)
Other useful de…nitions:
FDI
Investment made by multinational in the Foreign country
Parent
Company making the investment abroad
A¢ liate
Company receiving the investment abroad
14.581 (Week 12)
Multinationals Theory (I)
Fall 2011
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Horizontal MNEs
The proximity-concentration trade-o¤
Basic Idea:
Under free trade, you would never want to have production facilities in
multiple countries (why replicate …xed costs?)
But in the presence of transport costs, …rms may be willing to set up a new
plant in order to avoid these costs
Proximity-concentration trade-o¤:
Domestic …rm: low …xed cost, but high variable costs
Horizontal multinational: high …xed cost, but low variable costs
Main insight: Multinationals will be more likely if
1
2
3
Transport costs are higher
Plant-speci…c costs are lower
GDPs are higher or more similar across countries
14.581 (Week 12)
Multinationals Theory (I)
Fall 2011
4 / 19
Markusen and Venables (2000)
Assumptions
Consider a world economy with:
Two countries indexed by c = H,F
One di¤erentiated good produced under IRS by monopolistically competitive
…rms as in Krugman (1980)
One factor of production, labor
Labor requirement is given by:
l = f +q
where f
plant-speci…c …xed cost
There are iceberg trade costs between countries:
In order to sell 1 unit abroad, domestic …rms must ship τ > 1
14.581 (Week 12)
Multinationals Theory (I)
Fall 2011
5 / 19
Markusen and Venables (2000)
Equilibrium pro…ts
The pro…ts of multinationals and domestic …rms are given by
Π
M
Π
H
Π
F
!1
=
1
σ
pH
PH
=
1
σ
pH
PH
=
1
σ
τp H
PH
!1
!1
σ
!1
Y
H
1
+
σ
pF
PF
Y
H
1
+
σ
τp F
PF
σ
σ
Y
H
1
+
σ
pF
PF
!1
!1
σ
YF
wH + wF f
σ
YF
wH f
YF
wF f
σ
where:
pc
wc
Yc
σ 1
σ
βw c ,
wage in country c,
GDP in country c
14.581 (Week 12)
Multinationals Theory (I)
Fall 2011
6 / 19
Markusen and Venables (2000)
Predictions
Claim: MNEs are more likely if: (i ) transport costs are high, (ii ) …xed costs
are low, or (iii ) GDPs are higher or more similar
Sketch of Proof:
1
2
MNEs will be observed i¤
1
σ
pF
PF
1 σ
1
σ
pH
PH
1 σ
1
σ
τp F
PF
1 σ
wF f
1
σ
τp H
PH
1 σ
Y H wHf
YF
YF
YH
This implies
1
τ2
1 σ
YHYF
σw H fY F
14.581 (Week 12)
pH pF
PH PF
τp H
PF
1 σ
1 σ
+σw F fY H
Multinationals Theory (I)
τp F
PH
1 σ
+ σ2 w H w F f 2
Fall 2011
7 / 19
Markusen and Venables (2000)
Predictions
Sketch of Proof (Cont.): (i ) and (ii ) directly follow. In order to get (iii ),
let us divide the previous inequality by Y H + Y F
1
τ
2
1 σ
Y
H
σw fs
H
F
+Y
F
τp H
PF
1
!1
s
2
H
s
σ
F
+σw fs
H
F
2
τp F
PH
!1
pH pF
PH PF
σ
+
!1
σ
σ2 w H w F f 2
YH +YF
Intuition for (iii): it is not pro…table to pay extra …xed cost to serve a very
small market (no matter how large the trade costs)
With multiple factors of production, MNEs are more likely if factor
endowments are similar across countries
14.581 (Week 12)
Multinationals Theory (I)
Fall 2011
8 / 19
Helpman, Melitz and Yeaple (2004)
Overview
Helpman, Melitz and Yeaple (2004) revisit the proximity-concentration
trade-o¤ in the presence of …rm-level heterogeneity à la Melitz (2003)
Basic Idea:
Low-variable costs matter relatively more for more productive …rms
So high productivity …rms will become multinationals, whereas less productive
…rms will become exporters
Main insight:
Di¤erences in the distribution of …rm productivity across sectors has
implication for export vs. FDI
14.581 (Week 12)
Multinationals Theory (I)
Fall 2011
9 / 19
Helpman, Melitz and Yeaple (2004)
Model
k
Firm productivity ϕ is drawn from a Pareto, G ( ϕ) = 1
ϕ/ϕ
Firm in country i chooses whether to become domestic producers (D) or to
serve country j via exports (X ) or FDI (I ).
Foreign revenues are given by rO ( ϕ) = ( ϕ/τ O )σ
τ 1I σ
Variable transport costs satisfy:
=1>
Fixed transport costs satisfy: fI > fX > fD
14.581 (Week 12)
Multinationals Theory (I)
τ 1X σ
1
B, with O 2 fD, X , I g
> τ 1D
σ
=0
Fall 2011
10 / 19
Horizontal FDI: Helpman, Melitz and Yeaple (2004)
Selection into exports and FDI
14.581 (Week 12)
Multinationals Theory (I)
Fall 2011
11 / 19
Helpman, Melitz and Yeaple (2004)
Prediction
Industries with higher dispersion of productivity across …rms— i.e. a lower
shape parameter k— should have a higher ratio of FDI versus export sales
Intuition:
Low-k sectors have relatively more high-ϕ …rms
high-ϕ …rms are more likely to select in I than X
Formally:
g is log-supermodular in ϕ and k; r is supermodular in ϕ and τ 1
log-supermodularity is preserved by integration (Costinot 2009)
14.581 (Week 12)
Multinationals Theory (I)
σ;
and
Fall 2011
12 / 19
Vertical MNEs
In models of horizontal MNEs, trade and FDI are substitutes
But MNEs account for a very signi…cant fraction of world trade ‡ows and FDI
is rising with trade!
There is substantial trade of intermediate inputs within MNEs
Basic Idea:
Factor price di¤erences may provide incentives to operate (skill intensive)
headquarter services in North and do (labor intensive) production in South
Key insight:
Ability of MNEs to spread their facilities across several countries enlarges the
region of factor price equalization
14.581 (Week 12)
Multinationals Theory (I)
Fall 2011
13 / 19
Helpman (1984)
Assumptions
The basic environment is a 2
competition in one sector:
2
2 HO model with monopolistic
2 goods, 1 and 2
2 factors, H and L
Good
a1L
a1H
Good
1 is homogeneous good produced with CRS production:
unskilled labor requirement per unit of good 1
skilled labor requirement per unit of good 1
2 is a di¤erentiated good produced under MC:
c2 ( w u , w s , y ) = w s f + w u y
Factor content of production in sector 2:
a2L = y
unskilled labor requirement per variety of good 2
a2H = f
skilled labor requirement per variety of good 2
14.581 (Week 12)
Multinationals Theory (I)
Fall 2011
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Helpman (1984)
Integrated Equilibrium
ls
Os
v
hs
vs
vn
hn
On
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ln
Multinationals Theory (I)
Fall 2011
15 / 19
Helpman (1984)
Comments
The model does not feature intra…rm trade in physical goods. Notice,
however, that in the model there are invisible exports of headquarter services
from the parent to its subsidiaries
This may explain why observe trade de…cits in skill-abundant countries (these
are o¤set by receipts from subsidiaries abroad)
Assuming that these services are valued at average cost, Helpman (1984)
derives some interesting results that complement and qualify the predictions
of the benchmark Helpman-Krugman for the volume of international trade
and its components
1
2
3
The larger the role of multinational …rms in the world economy, the weaker the
e¤ects of relative country size dispersion on the volume of trade
For a given relative size of countries, the share of intra…rm trade in the total
volume of trade is increasing in relative factor endowment di¤erences
The larger the role of multinational …rms in the world economy, the weaker the
e¤ects of relative factor endowments on the share of intraindustry trade in the
total volume of trade.
14.581 (Week 12)
Multinationals Theory (I)
Fall 2011
16 / 19
Quantitative Models of MNEs
Main focus of previous papers is to explain why MNEs may emerge
But there is little discussion of the welfare implications of MNEs
Ramondo and Rodriguez-Clare (2009) have developed an extension of Eaton
and Kortum (2002) with both trade and multinational production (MP):
As in models of horizontal MNEs, trade and MP are alternative ways to serve
a market
As in models of vertical MNEs, foreign a¢ liates import intermediates from
parent
Also “Bridge MP”: …rm from country 1 produces in country 2 and exports in
country 3
Using trade and MP data, model can be calibrated to quantify gains form
openness, trade, and MP
14.581 (Week 12)
Multinationals Theory (I)
Fall 2011
17 / 19
Ramondo and Rodriguez-Clare (2009)
Model
Ideas get originated in country i
Production take place in country l
Consumption takes place in country n
Model is Ricardian with constant unit cost of production and delivery for a
good v given by
dnl cli
zli (v )
where:
dnl
iceberg trade costs between
cli
average unit cost of production for …rms from i in country l
zli (v ) productivity of …rms from i producing good v in country l
14.581 (Week 12)
Multinationals Theory (I)
Fall 2011
18 / 19
Ramondo and Rodriguez-Clare (2009)
Results
Main result:
Gains from trade are larger in the presence of MP because trade facilitates MP
Gains from openness are larger than gains from trade because of MP and
complementarity between trade and MP
Compared to previous models of MNEs, model is very reduced form:
in any given country and sector, technology is assumed to be freely available
to a large number of price-taking …rms
discipline only comes from aggregate predictions of the model
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Multinationals Theory (I)
Fall 2011
19 / 19