Among its many effects, the COVID-19 pandemic suddenly brought trade issues home for many households, with terms like “supply chain,” “logistics,” and “global value chains” (whereby production occurs in stages across countries), used to explain empty store shelves and other shortages. For domestic policymakers, the desire to address product shortages and related issues was hampered by the interrelated nature of these global supply chains. There was no quick and easy fix.
The same was true for economic researchers, whose existing trade models could not adequately capture the propagation of shocks that spread, domino-like, across countries. Take, for example, an earlier episode when the United States placed anti-dumping duties on washing machine imports from Korea in 2012. While standard trade models predict an increase in US washing machine prices, those prices actually fell as Korean manufacturers relocated production to China, thus increasing Chinese exports to the United States and countering the measures directed at Korea. Exports of washing machine parts from Korea to China also rose, highlighting the importance of multinational firms’ use of imported inputs by their affiliates. Clearly, standard models were missing the big picture.
The authors address these and other theoretical and empirical gaps by studying the relationship between firms’ foreign production locations and their international trade patterns. They construct a comprehensive new dataset that captures the domestic and foreign activities of all firms with US operations. They focus on firms that manufacture in the United States and define US multinational firms (MNEs) as those with majority-owned foreign manufacturing affiliates; foreign MNEs are majority owned by a foreign ultimate parent.
The authors also develop a multi-country model in which firms jointly decide the countries in which to produce final goods, source their inputs, and market their goods. The model features a new source of scale economies in which the fixed costs to source inputs from, or market goods in, a particular country are shared across all of the firm’s plants. That is, this new model more closely reflects reality. The authors find the following:
Bottom line: MNEs trade with disproportionately more countries than domestic firms, and those countries are closer to their foreign production locations. The authors’ new theoretical approach reflects how firms make sourcing and export decisions, with important implications for policy. For example, this work reveals that a bilateral trade agreement between two countries can generate third market effects, as firms in other countries have increased incentives to open plants there. Such positive indirect effects of trade policy on foreign direct investment undermine arguments for trade protection.