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2014 | OriginalPaper | Chapter

Foreign Direct Investment with Matching Frictions

Author : Hitoshi Sato

Published in: Internationalization of Japanese Firms

Publisher: Springer Japan

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Abstract

Firm-level data often show different modes of market access by firms with same productivity levels, which presents a knife-edge scenario in the standard Melitz-type firm heterogeneity model. Further, the standard Melitz-type model fails to explain another empirical regularity: the foreign affiliates’ sales relative to those generated by parent firms in their home market decrease with distance between the host and home countries. This chapter examines the foreign direct investment (FDI) decisions of individual firms with a simple framework, where firms and managers have to make matches for production. We find that the predicted distributions of FDI firms are much more akin to real data than those suggested by the basic firm heterogeneity model; namely, there exists a range of firm productivity in which more productive firms may export, whereas less productive firms may undertake FDI. Such a range of firm productivity becomes wider when either matching frictions increase or trade costs decline. Furthermore, the model predicts that the FDI sales relative to those generated by FDI firms in their home market decrease in the degree of matching frictions, which sheds some light on the empirical finding about the FDI sales relative to home sales by multinationals.

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previous chapter Productivity and Modes of Internationalization: Evidence from Japanese Firms

next chapter Intra-Firm Trade and Contract Completeness: Evidence from Japanese Foreign-Affiliated Firms

For example, see Bernard and Jensen (1995, 1999) for U.S. firms, Mayer and Ottaviano (2007) for European firms, Wakasugi et al. (2008) and Kimura and Kiyota (2007) for Japanese firms. Moreover, it is widely known that firms owning foreign production facilities are more productive than those engaged in only exports (e.g., Tomiura (2007) and Yeaple (2009)).

Bernard et al. (2007) extend the Melitz model by using it in the Heckscher–Ohlin framework. Bustos (2007) incorporates technology adoption into the Melitz model and shows that exporters tend to adopt more advanced technology.

Here “mangers” can be broadly interpreted as business partners with whom firms operate foreign subsidiaries. Thus, in this paper, FDI can take the form of a joint venture, M&A, or a green-field FDI.

I do not consider the possibility that firms cannot meet any managers. This possibility introduces additional matching frictions, such as unemployed managers and recruitment firms. The introduction of such matching frictions into the model may be an interesting extension. However, it seems unnecessary for the current purpose of the model. To avoid the issue of unemployed managers and recruitment firms, I simply assume a hypothetical matching market-maker who can arbitrarily adjust the mass of managers matching with firms.

In reality, it is observed that firms send managerial-class employees to foreign affiliates instead of hiring those locally. However, these behaviors seem to be limited to only the early stage of FDI.

The literature on firm heterogeneity and international trade typically assumes that \(f_{I} {>\tau }^{\sigma -1}f_{X}\) where f _I and f _X are fixed costs for FDI and exports, respectively, and τ is the usual iceberg-type transportation cost. See, for example, Helpman et al. (2004). In reality, there exists various types of fixed costs for MNEs to run foreign affiliates. The model obviously abstracts many of them. However, adding these fixed costs to the model does not essentially alter the model.

As λ marginally increases, the average match quality for firms with productivity greater than \(\varphi _{h}\) clearly improves.

Mayer and Ottaviano (2007) report that it is 3.03 and 2.55 for Italy and France. Wakasugi et al. (2008) estimate that k is approximately 1.7 for Japanese firms. This estimate appears significantly small. There is a possibility that the data set used in their study might suffer from a lack of data, especially for small firms. Eaton et al. (2011) find that k∕(σ − 1) is approximately 1.5 for French firms. Here, we use this ratio for setting k = 6.

The conditional probability density function of FDI firms is relegated to the Appendix.

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Title: Foreign Direct Investment with Matching Frictions
Author: Hitoshi Sato
Publisher: Springer Japan
Book: Internationalization of Japanese Firms
Print ISBN: 978-4-431-54531-6

Electronic ISBN: 978-4-431-54532-3

Copyright Year: 2014
DOI: https://doi.org/10.1007/978-4-431-54532-3_7