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. Making up more than half of all vertical FDI, these subsidiaries are not readily explained by the comparative advantage considerations in traditional models, where firms locate their low skill production stagesabroad 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 650,000multinational 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 significantlydifferent 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 tend to own the stages of production proximate to their final production giving rise to a class of high-skill intra-industry vertical FDI.
Publication Type: WCFIA Working Paper
Published Date: February 2007
Field of Interest: International Economics
Alfaro, Laura, and Andrew Charlton. “Intra-Industry Foreign Direct Investment.” Working Paper 2007-19, WeatherheadCenter for International Affairs, HarvardUniversity, 2007.