Multinational firms, value chains, and vertical integration.

• Author: Alfaro, Laura

In recent decades there has been a very rapid increase in flows of goods and capital between countries and between firms, driven by technological progress and falling cross-border restrictions. The rising ability to retain or outsource various production stages within firms and across country boundaries has fueled fragmentation of production and the emergence of global value chains. Cross-border production, investment, and trade in final and intermediate goods by multinational corporations (MNCs) are key drivers of this phenomenon.

In a series of papers combining new firm-level datasets and novel insights from trade and organizational economics, my colleagues and I have examined the characteristics and determinants of MNCs, value chains, and vertical production. We have found new patterns of foreign direct investment (FDI), and investigated the relationships among market conditions, vertical integration, and the effects of foreign capital.

We document the emergence of new MNC industrial clusters and their distinct agglomeration patterns. The organizational choices that firms make in structuring their value chains suggest that complex production and process decisions involving multiple stages explain intra-firm activity. Our work enhances understanding of the sources of productivity gains and resilience to external shocks afforded to host countries by MNC activity and cross-border vertical relations.

Global Patterns of MNC Activity

Agglomeration

One strand of my research has examined the geographic concentration of the plants operated by MNCs, and compared that concentration with the analogous pattern for domestic firms. Maggie Chen and I find evidence of MNC clusters, which we label agglomeration. (1) MNCs' offshore subsidiaries' higher productivity, vertically integrated production, and higher knowledge- and capital-intensities all suggest that their motives for agglomeration are different from those of domestic firms. We quantify patterns of spatial location by constructing an index of agglomeration that compares establishments at both the industry and plant levels. (2) The index quantifies the extent to which MNC establishments are more or less likely to agglomerate than their domestic counterparts. Dun and Bradstreet's WorldBase data enables us to compute this index based on plant-level observations. The dataset includes primary and secondary industries, ownership information, and plant-level physical location, which can be used to calculate the distance between pairs of establishments.

Our comparative analysis generates a rich array of new findings. MNC headquarters are, on average, the most agglomerative, meaning that they are most concentrated geographically. Headquarters facilities are followed by MNC foreign subsidiaries and domestic plants in their degree of concentration. The differences in the degree of agglomeration of these three different types of facilities suggest that MNC offshore clusters are not simply a reflection of domestic industrial ones.

Figure 1, on the following page, plots the distributions of pairwise industries' agglomeration densities, computed using a distance of 50 km to define "close" establishments for MNC foreign subsidiaries and domestic plants, respectively. MNC foreign subsidiaries are more agglomerative than domestic plants in capital-, skilled labor--, and R&D-intensive industries. In industries with greater than median levels of capital intensity, the distribution of agglomeration indices is rightward-shifted for MNC foreign subsidiaries compared to domestic plants. This pattern is similarly observed for industries with greater than median levels of skilled labor and R&D intensities. We also evaluate how agglomeration economies, particularly input-output linkages, labor and capital goods market externalities, and technology diffusion, affect MNCs relative to domestic firms. We find that MNCs' choice of location is significantly influenced by technology diffusion and capital-good market externalities.

These findings are largely consistent with the MNCs' vertically integrated organizational form and substantial investment in technology and capital goods, as well as with the increasing segmentation of activities within firm boundaries and increasingly complex sourcing strategies.

Intra-Industry FDI

Andrew Charlton and I show that large FDI flows across rich countries associated with these more complex strategies do not fit the traditional classification of horizontal FDI. (3) Although patterns of foreign investment are recognized as complex, the literature has traditionally, for analytical simplicity, distinguished between two forms of, and motivations for, locating activities abroad: horizontal--replicating a subset of activities or processes in another country, and vertical--fragmenting production by function. In general, market access models are favored empirically over comparative advantage models. Our results suggest that data limitations have led the prior studies to...