Networks of foreign affiliates: Evidence from Japanese micro‐data

• DOI: http://doi.org/10.1111/twec.12963
• Author: Francesca Spinelli,Dorothée Rouzet,Hongyong Zhang
• Date: 01 July 2020
• Published date: 01 July 2020

World Econ. 2020;43:1841–1867. wileyonlinelibrary.com/journal/twec

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1841

© 2020 John Wiley & Sons Ltd

Received: 9 January 2019

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Revised: 7 March 2020

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Accepted: 24 April 2020

DOI: 10.1111/twec.12963

ORIGINAL ARTICLE

Networks of foreign affiliates: Evidence from

Japanese micro-data

FrancescaSpinelli1

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DorothéeRouzet1

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HongyongZhang2

1OECD, Paris, France

2RIETI, Tokyo, Japan

Funding information

JSPS KAKENHI, Grant/Award Number: 17H02531 and 17H02554

1

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INTRODUCTION

Multinational firms face complex decisions regarding where and how to set up their activity across

multiple locations and markets. With the rising role of global value chains in the production of goods

and services, advances in technology as well as a complex landscape of trade and investment agree-

ments, these strategies go well beyond a ‘proximity-concentration’ trade-off between exporting and

establishing to capture a given market, or exploiting cost differences to determine an optimal pro-

duction site. Location choices are likely to take into account complementarities between markets,

for instance by establishing in a host country offering a favourable environment to deal with local

customers but also to export to third countries within a regional bloc. They are also influenced by

complementarities between activities, reinforced by the blurring of boundaries between physical prod-

ucts and services as digitalisation progresses, and the role of services in adding value to the provision

of manufacturing goods. Multinational enterprises (MNEs) set up affiliates in industries different

from their own and can exploit synergies between their production plants and services affiliates, for

instance in distribution or logistics, to gain efficiency and market share in their various markets. This

complex web of considerations makes it more challenging for policymakers to identify well-targeted

levers to effectively boost their country's attractiveness to FDI.

This paper sheds light on these complementarities between locations and between activities using

micro-data from Japan's Basic Survey of Overseas Business Activities, which contains detailed in-

formation on the activities of foreign affiliates of Japanese companies. Compared to affiliate sales

data from other countries, Japanese data stands out for its fine breakdown of sales and purchases by

destination. Japanese micro-data on firms’ international activities has been previously used mostly for

the manufacturing sector and to study the productivity and size premium of multinational enterprises;

but to the best of our knowledge, much less attention has been paid to how policies can affect location

choices in services and taking into account interdependences between potential destinations.

We explore the unique granularity of the Japanese microdata to analyse in more depth the location

choices for both foreign manufacturing and services affiliates, distinguishing between three main

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SPINELLI Et aL.

motives: serving the local market, providing goods and services within their corporate group, and

providing goods and services to third countries regionally or globally. The early literature on FDI

drivers set out a distinction between horizontal and vertical FDI. On the one hand, FDI can be driven

by market access motives.1 In these cases, the primary goal is to serve the local market: the parent firm

replicates its production process for goods and services in the host market to serve local demand, in

order to save on transaction and transport costs and gain more reactivity to local market conditions, at

the expense of lower economies of scale. On the other hand, FDI can respond to efficiency-seeking

motives or comparative advantage motives.2 This type of FDI consists in offshoring all or part of the

production process by undertaking either the production of goods and services inputs, or final product

assembly abroad to serve the firm's home country, and differences in factor endowments and factor

prices should shape its distribution across countries. More generally, FDI related to slicing up global

value chains is well captured by the existence of affiliates whose clients are either the parent firm itself

or other affiliates within the parent firm's corporate network.

However, in many instances FDI location choices are of a more complex nature than this dichot-

omy. 3 In particular, this paper aims to shed new light on the importance and drivers of export platform

FDI, which mixes market-serving and production offshoring motives: it consists in producing goods

and services in a given host market to further export to third countries, or acting as a distributional

hub. Export platforms are likely to be chosen based on both cost and efficiency of production condi-

tions (labour, taxation, logistics, business environment, etc.), and ease of access to destination markets

(e.g., proximity to regional demand centres).

The paper explores the structural and policy determinants of FDI attractiveness. It identifies signif-

icant policy drivers that influence the location patterns of not only foreign establishments directed to-

wards the local market, but also MNE affiliates that help host countries integrate into segments of global

value chains and enhance their export performance. The novel contribution of our analysis is threefold.

First, we provide a consistent empirical framework to study the relationship between a number of poten-

tial structural, geographical and policy drivers of host country attractiveness across the three motives of

FDI and across goods and services sectors, allowing us to test existing theories of FDI drivers at a more

granular level than most existing studies. Second, we provide new evidence on the policy factors of loca-

tion choices for export platform FDI, which has been relatively under-studied in the empirical literature.

Third, we also provide new insights on how services FDI differs from manufacturing FDI, both in terms

of parent and affiliate descriptive characteristics and in its sensitivity to trade policy and other policy

tools. In particular, while there is a large empirical literature on manufacturing FDI, intra-firm trade and

export-platform FDI in services have to our knowledge received little attention in the existing literature.

Our data first reveals several interesting stylised facts on the nexus between parent and affiliate activity.

On average, MNEs with services affiliates are significantly larger and have twice as many affiliates, as

MNEs with affiliates producing goods, suggesting large fixed costs of international expansion in services.

Regarding the final destination of affiliate sales, we find that export platform activity accounts for a large

share of affiliate sales in some host countries, both in manufacturing and services, mostly to serve regional

1Firms that decide to substitute trade with FDI by locating their plants in multiple countries to maximise their proximity to

local customers and to skip the costs associated with international trade, being those transportation/transactional costs or

policy-induced trade barriers (Markusen & Venables,2000).

2Firms that fragment their production process across multiple locations where the resources, assets or factors used more

intensively are relatively cheaper than in the home country, in other words where the main rationale for investing abroad is to

exploit factor endowment differences and the differential in their relative costs (Helpman,1984).

3The knowledge-capital model introduced by Markusen (1997) was an early contribution to bridging the dichotomy between

horizontal and vertical FDI. See Carr etal.(2000) for an empirical application of this model.