Macroeconomics

Foreign direct investment

Economics

International trade

Monetary economics

International economics

American Economic Review

Multinational sales have grown at high rates over the last two decades, outpacing the remarkable expansion of trade in manufactures. Consequently, the trade literature has sought to incorporate the mode of foreign market access into the “new” trade theory. This literature recognizes that  rms can serve foreign buyers through a variety of channels: they can export their products to foreign customers, serve them through foreign subsidiaries, or license foreign  rms to produce their products. Our work focuses on the  rm’s choice between exports and “horizontal” foreign direct investment (FDI). Horizontal FDI refers to an investment in a foreign production facility that is designed to serve customers in the foreign market. Firms invest abroad when the gains from avoiding trade costs outweigh the costs of maintaining capacity in multiple markets. This is known as the proximity-concentration tradeoff. We introduce heterogeneous  rms into a simple multicountry, multisector model, in which  rms face a proximity-concentration trade-off. Every  rm decides whether to serve a foreign market, and whether to do so through exports or local subsidiary sales. These modes of market access have different relative costs: exporting involves lower  xed costs while FDI involves lower variable costs. Our model highlights the important role of within-sector  rm productivity differences in explaining the structure of international trade and investment. First, only the most productive  rms engage in foreign activities. This result mirrors other  ndings on  rm heterogeneity and trade; in particular, the results reported in Melitz (2003). Second, of those  rms that serve foreign markets, only the most productive engage in FDI. Third, FDI sales relative to exports are larger in sectors with more  rm heterogeneity. Using U.S. exports and af liate sales data that cover 52 manufacturing sectors and 38 countries, we show that cross-sectoral differences in  rm heterogeneity predict the composition of trade and investment in the manner suggested by our model. We construct several measures of  rm heterogeneity, using different data sources, and show that our results are robust across all these measures. In addition, we con rm the predictions of the proximityconcentration trade-off. That is,  rms tend to substitute FDI sales for exports when transport * Helpman: Department of Economics, Harvard University, Cambridge, MA 02138, Tel Aviv University, and CIAR (e-mail: ehelpman@harvard.edu); Melitz: Department of Economics, Harvard University, Cambridge, MA 02138, National Bureau of Economic Research, and Centre for Economic Policy Research (e-mail: mmelitz@ harvard.edu); Yeaple: Department of Economics, University of Pennsylvania, 3718 Locust Walk, Philadelphia, PA 19104, and National Bureau of Economic Research (e-mail: snyeapl2@ssc.upenn.edu). The statistical analysis of  rmlevel data on U.S. Multinational Corporations reported in this study was conducted at the International Investment Division, U.S. Bureau of Economic Analysis, under an arrangement that maintained legal con dentiality requirements. Views expressed are those of the authors and do not necessarily re ect those of the Bureau of Economic Analysis. Elhanan Helpman thanks the NSF for  nancial support. We also thank Daron Acemoglu, Roberto Rigobon, Yona Rubinstein, and Dani Tsiddon for comments on an earlier draft, and Man-Keung Tang for excellent research assistance. 1 See Wilfred J. Ethier (1986), Ignatius Horstmann and James R. Markusen (1987), and Ethier and Markusen (1996) for models that incorporate the licensing alternative. We therefore exclude “vertical” motives for FDI that involve fragmentation of production across countries. See Helpman (1984, 1985), Markusen (2002, Ch. 9), and Gordon H. Hanson et al. (2002) for treatments of this form of FDI. 3 See, for example, Horstmann and Markusen (1992), S. Lael Brainard (1993), and Markusen and Anthony J. Venables (2000). 4 See also Andrew B. Bernard et al. (2003) for an alternative theoretical model and Yeaple (2003a) for a model based on worker-skill heterogeneity. James R. Tybout (2003) surveys the recent micro-level evidence on trade that has motivated these theoretical models. 5 This result is loosely connected to the documented empirical pattern that foreign-owned af liates are more productive than domestically owned producers. See Mark E. Doms and J. Bradford Jensen (1998) for the United States and Sourafel Girma et al. (2002) for the United Kingdom.

Export Versus FDI with Heterogeneous Firms