Production Costs Associated With Multinational Trade Model

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1 Global Production with Exports Platforms Felix Tintelnot by Lian Allub-UC3M 24/06/2013 Felix Tintelnot (by Lian Allub-UC3M) Global Production with Exports Platforms 24/06/ / 18

2 Motivation Most international commerce is done by multinational firms These firms use foreign affiliates for most of their foreign sales International trade models achieve tractability by: Assumming away exports platforms; or Ignoring fixed costs of foreign investment This paper: Incorporates exports platforms Incorporates fixed cost of foreign investment Multi-product per firm Felix Tintelnot (by Lian Allub-UC3M) Global Production with Exports Platforms 24/06/ / 18

3 Questions this paper aims to answer What are the costs associated with multinational production? How important are fixed relative to variable costs of foreign operations? How do a fall in these costs affect the structure of global production? With globalization: Will firms concentrate or expand the number of production locations? How does MP affect the welfare effects in a GE trade model? Felix Tintelnot (by Lian Allub-UC3M) Global Production with Exports Platforms 24/06/ / 18

4 Environment Static model Geographic barriers: Iceberg trade costs, τ Efficiency losses in foreign production, γ Fixed cost to establish foreign plants, η Countries differ in Labor endowments Mass and distribution of firms Monopolistic Competition No fixed cost of exporting Felix Tintelnot (by Lian Allub-UC3M) Global Production with Exports Platforms 24/06/ / 18

5 Demand CES preferences Each firm sells a continuum of products. There is a measure 1 of varieties per firm and a fix measure of firms Utility of a representative consumer from j ( (1) U j Ω 1 Utility maximization implies: q j (ω, ν) = p j (ω, ν) σ Y j 0 ) σ/(σ 1) q j (ω, ν) (σ 1)/σ dνdω Pj 1 σ ( 1 1/(1 σ) p j (ω) 0 p j (ω, ν) dν) 1 σ [ ] 1/(1 σ) P j Ω p j j (ω) 1 σ dω Felix Tintelnot (by Lian Allub-UC3M) Global Production with Exports Platforms 24/06/ / 18

6 Firm s problem Firms behave as monopolist Face a CES demand function for each product Take price indices, income and wages as given A firm is characterized by: Timing: Country of origin, i Core productivity φ Vector of fixed cost levels in every country, η Location-specific productivity shifters, ɛ Firms draw the core productivity φ and fixed cost η Decide production locations Learns ɛ Felix Tintelnot (by Lian Allub-UC3M) Global Production with Exports Platforms 24/06/ / 18

7 Productivity and costs CDF of a product s productivity in country j: Pr(v j x) = exp ( (φɛ j ) θ (γ ij x) θ) Cost for a firm originated in i to serve market m from l: c ilm = γ il w l τ lm φɛ l Fixed cost of producing in l: η l = η l w l Firms select for each product and market, the production location that can supply that market at the minimum cost Benefits of setting up foreign plants: Proximity to local and surrounding markets. May have lower factor prices Has a comparative advantage in the production of some firm s product. Costs of setting up foreign plants: Fixed cost for establishing a foreign plant Productivity loss γ of producing abroad Felix Tintelnot (by Lian Allub-UC3M) Global Production with Exports Platforms 24/06/ / 18

8 Data Firm-level data on German multinational firms. Manufacturing sector for the year 2005 Activities in twelve Western Euopean and North American countries Observed total sales for affiliates as well as for parent company 1,711 positive firm-country output observations from 665 firms Gross production and bilateral trade flows data are from OECD STAN Felix Tintelnot (by Lian Allub-UC3M) Global Production with Exports Platforms 24/06/ / 18

9 Estimation η k LN(µ η, σ η ) drawn independently across countries and firms Set η = 0 and normalize unit input cost w = wγ to 1 in Germany Location-specific productivity shifter ɛ is drawn from LN with (0, σ ɛ ) independently across countries and firms Core productivity φ: Pareto with scale µ φ and shape σ φ Set elasticity of substitution σ = 6 Dispersion of the country-firm specific productivity shifters θ = 7 Use a constrained Maximum likelihood Estimation to get w, µ η, σ η, µ φ, σ φ and σ ɛ and firm-country specific productivity levels Table 1 Felix Tintelnot (by Lian Allub-UC3M) Global Production with Exports Platforms 24/06/ / 18

10 Calibration Calibrate: Trade costs Variable foreign production costs Fixed costs of setting up foreign affiliates Use as targets: Bilateral trade flows Values of output of firms from country i in country l Estimates of country-specific variable production costs of German multinationals. Solve for relative wage and price indices in every country. Data: Gross manufacturing production and bilateral trade OECD STAN Multinational production Ramondo, Rodriguez-Clare and Tintelnot Labor endowments Penn World Tables Educational attainment levels Barro and Lee (2010) Felix Tintelnot (by Lian Allub-UC3M) Global Production with Exports Platforms 24/06/ / 18

11 Sources of Home Bias in production Try different levels of fixed and variable costs Both fixed and variable costs are important for home bias Felix Tintelnot (by Lian Allub-UC3M) Global Production with Exports Platforms 24/06/ / 18

12 Counterfactuals Conduct several counterfactuals analysis Potential effects from a Canada-EU trade investment agreement Lowers fixed and variable MP costs by 20% Table Benefits of foreign technology All US firms improve their core productivity levels by 20% Table Gains from: Trade: Welfare gains when going from benchmark to one with infinite trade costs MP: Change in real income when going from a case with infinite MP cost to the benchmark Openness: Welfare change when going from autarky to benchmark Felix Tintelnot (by Lian Allub-UC3M) Global Production with Exports Platforms 24/06/ / 18

13 Counterfactuals-Gains from Trade, MP and Openness Trade Gains from trade are slightly higher in pure trade models Smaller countries benefit more in both morels The increase in real profits is four times than the increase in real wages The level of MP increases when trade is prohibited MP Gains from MP are smaller than gains from trade Effect of MP on real profits is ambiguous Real profits tend to fall more in small than in large countries Openness Losses of not allowing trade and MP are larger than in previous cases Real wages change is similar to welfare change and real profits are roughly unchanged Small countries benefit more from openness than large countries Felix Tintelnot (by Lian Allub-UC3M) Global Production with Exports Platforms 24/06/ / 18

14 Estimation Results back to Estimation Felix Tintelnot (by Lian Allub-UC3M) Global Production with Exports Platforms 24/06/ / 18

15 Calibrated Parameters Felix Tintelnot (by Lian Allub-UC3M) Global Production with Exports Platforms 24/06/ / 18

16 Calibration Result Felix Tintelnot (by Lian Allub-UC3M) Global Production with Exports Platforms 24/06/ / 18

17 Canada-EU Investment Agreement back to Counterfactuals Felix Tintelnot (by Lian Allub-UC3M) Global Production with Exports Platforms 24/06/ / 18

18 Gains from US Technology Improvement back to Counterfactuals Felix Tintelnot (by Lian Allub-UC3M) Global Production with Exports Platforms 24/06/ / 18

Global Production with Export Platforms

Global Production with Export Platforms Felix Tintelnot Penn State August 15 2012 Abstract This paper develops and estimates a model of firms global location and production decisions. In the model, firms