Conferences at Department of Economics, University of Toronto, RCEF 2012: Cities, Open Economies, and Public Policy

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The Role of Manufacturing and Wholesale Aliates in Shaping the Geographic Organization of Multinational Firms: Theory and Evidence

Leo Karasik

Last modified: 2012-08-14

Abstract


How does a multinational firm organize its global operations? Standard models of FDI seeking
to answer this question typically omit at least one of four key features: (i) multinational firms
tend to underinvest in less attractive destinations, (ii) manufacturing affiliates do not sell their
entire output within the host market, (iii) there is evidence of inter-affiliate trade, and (iv)
multinationals regard wholesale affiliates as a form of FDI, contrary to the academic literature
that treats it as a form of exporting. I analyze the interaction of these four features in a three-
country heterogeneous firms model. In the model a fi rm can serve each market by exporting
through an intermediary, exporting to a wholesale affiliate or establishing a manufacturing
affiliate that relies upon imported intermediates from the parent. Moreover, I allow a fi rm to
serve neighboring markets from a manufacturing affiliate if doing so is pro table. I find that
entering one market (the more attractive one) increases the incentive to establish wholesale
affliates in a neighboring (less attractive) market in order to facilitate the import of products
produced in di erent destinations, thereby economizing on fixed costs. At the same time, this
also reduces the fi rm's incentive to establish a manufacturing site in a nearby market. I test
both predictions using data on the foreign operations of French MNCs. I find strong evidence
to support both. My fi ndings indicate that a firm's entry decision into a given country depends
upon its entry decisions elsewhere, and have implications for policies aimed at encouraging FDI.

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