DP7145 The Margins of Multinational Production and the Role of Intra-firm trade

Author(s): Alfonso Irarrazabal, Andreas Moxnes, Luca David Opromolla
Publication Date: January 2009
Keyword(s): Export, FDI, Gravity, Intra-firm Trade, Multinational Production
JEL(s): F10
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=7145

In this paper we ask why the gravity model of international trade also work well for foreign direct investment (FDI) flows or multinational production (MP). We propose a model of trade and horizontal FDI, where the subsidiary is allowed to source inputs from the headquarters. Under certain parameter values, the model will generate gravity relationships for both exports and MP. Matching the model with data using a unique firm-level dataset of both exports and MP reveals the following results. First, intra-firm trade appears to play a crucial role in shaping the geography of MP. Our conclusions are robust to any geographical distribution of fixed costs. Second, counterfactual experiments show that impeding FDI leads to reduced domestic labor demand by the headquarters, suggesting that outwards FDI may have positive effects on home employment.