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By S. LAEL BRAINARD *
This paper examines the extent to which multinational location decisions reflect a trade-off between achieving proximity to customers and concentrating production to achieve scale economies. It finds that overseas production by multinationals increases relative to exports the higher are transport costs and trade barriers and the lower are investment barriers and scale economies at the plant level relative to the corporate level. However, it is not possible to reject a model with only country and industry effects. The evidence also suggests that multinational activity is more likely the more similar are the home and foreign marketscontrary to conventional wisdom. (JEL F12, F21, F23)
Multinational enterprises play a key role in international competition. Alan Rugman (1988) estimates that the largest 500 multinationals control over one-half of global trade flows, and one-fifth of global GDP. For countries that have an extensive network of overseas affiliates, such as the United States, the United Kingdom, the Netherlands, and Switzerland, the sales of these affiliates tend to swamp export flows. In manufacturing and primary goods alone, local sales by U.S.-owned affiliates abroad are over four times greater than U.S. exports to the United Kingdom, Germany, Norway, Brazil, and Spain. It is also striking that, contrary to conventional wisdom, a large and growing share of multinational activity occurs between industrialized countries as both the source and destination markets, rather than flowing from North to South. Between 1961 and 1988, over half of all direct investment outflows from the five largest industrialized countries was absorbed by other countries within the same group; by 1988, this share had risen to nearly 70 percent (DeAnne Julius, 1990).
This paper explores the extent to which multinational production-location decisions can be explained by a trade-off between maximizing proximity to customers and concentrating production to achieve scale economies (Paul Krugman, 1983; Ignatius Horstmann and James Markusen,1992; Brainard,1993a). The proximity-concentration hypothesis predicts that firms are more likely to expand production horizontally across borders the higher are transport costs and trade barriers and the lower are investment barriers and the size of scale economies at the plant level relative to the corporate level.
These predictions differ substantially from the dominant explanation of multinational activity within traditional trade theory (Elhanan Helpman, 1984; James...