The Effect of Communication Costs on Trade in Headquarter Services∗

Communication is a real barrier to organizing international production as it hinders knowledge transmission. This paper provides evidence to suggest that a way in which multinational firms economize on costly information transfers is by using skilled foreign workers, since local talent can substitute for knowledge inputs from the headquarters. Combining U.S. data on headquarter service exports with information on communication costs and skill endowments by country, I find that while communication costs decrease the export of headquarter services to foreign affiliates, the effect becomes weaker in the average educational attainment of foreign workers. The sensitivity of headquarter service exports to communication barriers at low levels of skill endowment has important implications for the geography of multinational production, as well as for policies aimed at improving communication infrastructure. JEL Classification: F1