Size, Geography, and Multinational Production∗

This paper analyzes the cross-country determinants of multinational production (MP), quantifies its costs and impact on welfare. Three facts stand out: a small fraction of country-pairs engages in MP with each other; geography is a significant impediment to these activities; and country size matters. I introduce MP in a competitive, multi-country model, close to Eaton-Kortum (2002), in which firms can replicate technologies abroad at a cost. The model predicts zero as well as positive MP volumes, and delivers a gravity equation. Using new data on bilateral sales of affiliates, I estimate the cost of MP by matching simulated and actual moments. Estimates suggest that country-pairs twice as distant have 56% higher costs, and there are large gains of lowering MP costs, larger than the ones calculated from models with only trade. ∗I would like to thank Fernando Alvarez, Christian Broda, Thomas Chaney, William Fuchs, Hugo Hopenhayn, Robert Lucas, Robert Shimer, and Nancy Stokey, for their comments and discussions. I benefited from comments of participants in seminars at Arizona State U., Boston U., Berkeley, Santa Cruz, U. of Chicago, IIES, IMF, LSE, U. of Minnesota, MIT, NYU, Penn State, U. Pompeu Fabra-CREI, Princeton, U. Di Tella, Stern, U. of Texas-Austin, Chicago FRB, St. Louis FRB, Federal Reserve Board of Governors, U. of San Andrés, SED 2006, AEA-ES Meeting 2007, Midwest Trade Meeting 2007. Jeff Thurk provided excellent research assistance. All errors are mine. †E-mail: [email protected]