Research Summary

Intra-Industry Foreign Direct Investment (joint with Andrew Charlton)

by Laura Alfaro

Description

We identify a new type of vertical foreign direct investment (FDI) made up of multinational subsidiaries producing intermediate inputs, which are of similar skill intensity to the final goods produced by their parents, and which are overwhelmingly located in high skill countries. These subsidiaries make up more than half of all vertical subsidiaries and are not readily explained by the comparative advantage considerations in traditional models of vertical FDI, where firms locate their low skill production stages abroad in low skill countries to take advantage of factor cost differences. In this paper we exploit a remarkable new firm level data set which establishes the location, ownership, and activity of 650,000 multinational subsidiaries—close to a comprehensive picture of global multinational activity. A number of patterns emerge from the data. Most foreign direct investment (FDI) occurs between rich countries. The share of vertical FDI (subsidiaries which provide inputs to their parent firms) is larger than commonly thought, even within developed countries. More than half of all vertical subsidiaries are only observable at the four-digit level because the inputs they are supplying are so proximate to their parent firm’s final good that they appear identical at the two-digit level. We call these proximate subsidiaries ‘intra-industry’ vertical FDI and find that their location and activity are significantly different to the inter-industry vertical FDI visible at the two-digit level. We explain this pattern of intra-industry north-north vertical FDI in terms of the decision to outsource versus own the production of intermediate inputs. Overwhelmingly, multinationals source raw materials and inputs in early stages of production from outside the firm, but tend to own the stages of production proximate to their final production giving rise to a class of high-skill intra-industry vertical FDI.

Intra-Industry Foreign Direct Investment