Empirical tests of the new theory of multinational enterprise
Brainard S.L., (1997), An empirical assessment of the proximity concentration tradeoff between multinational sales
and trade, American Economic Review 87 (4), 520-544.
Hypothesis 1: Proximity-concentration tradeoff
Hypothesis 2: Factor proportion differences
Proximity-concentration hypothesis predicts that firms are more likely to expand production horizontally across borders the
higher are transport costs and barriers to trade, the lower the investment barriers and the size of scale economies at the plant
level relative to the firm level.
Factor proportions hypothesis predicts that firms integrate production vertically across borders to take advantage of factor
price differences associated with different relative factor supplies.
3 possible equilibria:
zero transport costs – pure trading equilibrium (no multinationals) – share of exports 100%
non-zero transport costs – mixed equilibrium (both trade and multinationals) – share of exports (0, 100%)
prohibitive transport costs – pure multinationals equilibrium (no trade) – share of exports 0%.
DATA: bilateral US activity
Brainard (1997) uses data on multinationals to examine whether the share of total sales to foreign markets accounted for by
overseas affiliate production, as opposed to exports, can be explained by the proximity-concentration tradeoff hypothesis.
 Outward MNE activity – sales by affiliates of U.S. firms and U.S. exports
 Inward MNE activity – sales by affiliates of foreign firms in the U.S. and U.S. imports
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1-year data (1989) disaggregated by industry and country(no individual country effects but industry-specific effects)
63 manufacturing and primary industries (3-digit SIC) and 27 countries
Research Methodology: gravity equation for the mixed equilibrium
The first estimating equation explains the share of total foreign sales accounted for by exports:
EXshi j   0  1 Freight ij   2Tariff i j   3 PWGDPi j   4TAX i
  5TRADE i   6 FDI i   7 PSCALE j   8 CSSCALE j   i j
Dependent variable:
EXsh - the log of the share of exports (by the U.S. firms) in total sales to foreign markets
Main Explanatory variables:
Freight – the log of transport costs and trade barriers: freight and insurance charges reported by importers to the US (for
exporters data not available)
Tariff – the log of ad valorem tariff rates on imports for 3-digit categories (simple averages and weighted)
PWGDP – the log of the absolute value of the differential in per worker GDP between the US and host country
Tax – the log of the average effective corporate income tax rate in host country
FDI and Trade Openness: the logs of indexes from the World Competitiveness Report
PScale and CScale economies: logs of plant and firm size measures
- plant scale economies in each industry measured by the number of people employed in the median U.S. plant (ranked
by value added)
- firm scale economies measured by the number of non-production workers in the average US based firm in each
industry
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Other explanatory variables:
LANG – language dummy: 1 if English, 0 otherwise
COUP – number of political coups in the last decade
ADJ – adjacency: 1 for common border (Canada and Mexico)
EC – European Union membership: 1 if EU member
ADVERT and RD – the logs of average advertising and R&D expenditures to sales ratios (proxies for internalization
advantages)
Empirical results
Empirical results lend support to the proximity-concentration hypothesis.
The first set of results shown in Tables 1-3 concerns the share of exports in total sales to foreign markets. Estimation
methods in Table 1 include: OLS (1), Random effects controlling for correlation of errors within country and industry
groups (2) (3), OLS with full set of variables (4), Random effects (5) (6). In Table 2 she presents generalized Tobit estimates
to address the large number of zero affiliate sales in her sample.
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The results are quite robust to the specification and indicate that:
- The estimated coefficients on both tariffs and freight costs appear to be negative and significant.
- Her measure of plant-level economies of scale turns out with a positive and significant coefficient, while the converse
is true for her measure of firm-level scale economies
- The coefficient on the difference in GDP per capita between the foreign country and the US is positive and significant
which suggests that differences in factor proportions tend to foster exporting more than FDI.
Brainard (1997) also runs the specification with country and industry fixed effects, thus dropping all variables but the
measures of transport costs. The results become weaker but the estimates are still for the most part of the right sign.
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Next Brainard repeats the exercise with the share of U.S. imports over U.S. imports plus sales of U.S.
affiliates of foreign firms. Her results are again broadly consistent with the theory, although the transport
cost measures lose some of their significance (especially tariffs).
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Finally, Brainard estimates outward sales by U.S. owned affiliates in foreign markets.
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Carr D.L., Markusem J.R., Maskus K.E., 2001, Estimating the knowledge capital model of the
multinational enterprise, American Economic Review 91 (3), 693 - 708.
Cross-country panel for U.S. firms that invested abroad (63 countries) for the period 1986-1994
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Dependent variable – the real volume of production, i.e. sales, by manufacturing affiliates in each host country that are
majority owned by parents in source country.
Explanatory variables:
GDP (+) joint market size – bigger countries = more multinational activity given transport cost
GDPDIFF2 (-) similarity in GDP – measure of the relative country size = bigger differences less multinational activity
SKILLDIFF (+) – measure of skilled labor abundance in the parent country relative to tge host country - the share of
professional, technical and administrative workers in total employment
GDPDIFFxSKILLDIFF (-) interaction term, the product of differences in size and endowments = affiliate sales are the
highest when the parent country is small and skilled-labor abundant
InvestmentCost (-) investment barriers, an average of several indices (various difficulties foreign investors might face in the
host country) from World Competitiveness Report (0-100)
TradeCost in the host country (+) measure of protectionism, World Competitiveness Report
TradeCostxSKILLDIFF (+) may encourage horizontal FDI (but not vertical)
TradeCost in the parent country (-) important for vertical MNEs that reexport their products back to the parent country
Distance (?) geographic distance measured in kilometers
Linear regression (not in logs), zero observations present in the sample
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3 estimation methods:
- OLS
- WLS
- Tobit
2 sets of estimates - without (Table 1) and with (Table 2) fixed effects at the country level (host country)
Controlling for the fixed effects does not change much the results but the role of skill differences is greatly reduced
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