Horizontal versus Vertical Interdependence in Multinational Activity Harald Badinger WU Vienna Peter H. Egger Ifo Institute

Starting point Economists for long categorized multinational (too) simplistically Economists for long categorized multinational (too) simplistically –Horizontal FDI (MNE’s don’t trade and produce everywhere the same good) –Vertical FDI (MNEs do research at home and production in countries like China)

New Theory on MNEs MNEs are complex (Yeaple, 03): MNEs are complex (Yeaple, 03): –Export platform FDI (Ekholm, Forslid, Markusen, 07) (combines horizontal & vertical aspects) –Components-trading MNEs (Grossman, Helpman, Szeidl, 07; Bergstrand & Egger, 08) (MNEs scatter and slice up goods production across int’l borders; within and across firms)

New Theory on MNEs MNEs’ complexity entails positive interdependence (complementarity) across host markets: MNEs’ complexity entails positive interdependence (complementarity) across host markets: –Export platform FDI faster growth abroad raises exports (profits) of platform plants –Intra-firm-components-trading MNEs faster growth abroad raises firm’s sales and demand for components from all subsidiaries

New Theory on MNEs Problem: From complementary among target market characteristics as such we can not conclude which theory is supported by data. Complementarity is generated by most models of complex FDI

New Empirics on MNEs Applies methods for interdependent observations to bilateral FDI (Blonigen, Davies, Wadell, Naughton, 07; Baltagi, Egger, Pfaffermayr, 07, 08) Applies methods for interdependent observations to bilateral FDI (Blonigen, Davies, Wadell, Naughton, 07; Baltagi, Egger, Pfaffermayr, 07, 08) Uses aggregate data on bilateral activity (FDI; foreign affiliate sales, FAS) Uses aggregate data on bilateral activity (FDI; foreign affiliate sales, FAS) Comes to the limited conclusion that there is indeed support for complex FDI Comes to the limited conclusion that there is indeed support for complex FDI YEAH, BUT WHICH ONE?

This Paper We employ three ingredients that hopefully will help us go beyond existing work We employ three ingredients that hopefully will help us go beyond existing work –Industry-level data on FAS –Input-output (IO) tables –Bilateral trade statistics

This Paper From IO-tables & trade flows, we construct two matrices of interdependence From IO-tables & trade flows, we construct two matrices of interdependence –Horizontal interdependence (H) (FAS in host j depend on determinants in other hosts but the same industry i) –Vertical interdependence (V) (FAS in host j depend on determinants of other industries, either in host j or abroad)

This Paper We use H and V to weight characteristics of FAS of j and abroad to construct horizontal and vertical interdependence variables We use H and V to weight characteristics of FAS of j and abroad to construct horizontal and vertical interdependence variables We do so for the observed and the unobserved variables with panel data We do so for the observed and the unobserved variables with panel data The latter requires extending existing estimation procedures with interdependent processes for panel data The latter requires extending existing estimation procedures with interdependent processes for panel data

The Empirical Model y t = X t b + u t ; u t = (r H H + r V V) u t + m + v t u t = (I - r H H - r V V) -1 (m + v t ) GM estimation of r H and r V.

Data You look for int’l data on bilateral FAS (or FDI) at the industry-level across (a few) years or even a cross-section? Good luck! Or better: forget it! The minimum we can do: look at U.S. FAS in Western Europe

Data Variables in X Variables in X - Size ijt of industry & host in year t (production vs. apparent cons.) - -Export openness ijt - -Import openness ijt - -Host x year fixed effects (dummies) - -Ind. x year fixed effects (dummies) - -Industry x host fixed effects (Mundlak, 1978)

Results (Scarce & Preliminary) Variable Model 1 Model 2 Model 3 Model 4 Ln size Ln H*size Ln V*size X-openn M-openn Within R

Conclusions We aim at disentangling the relative importance of Horizontal vs Vertical interdependence (not HMNEs vs VMNEs!) We aim at disentangling the relative importance of Horizontal vs Vertical interdependence (not HMNEs vs VMNEs!) This requires combining industry-level data of bilateral MNE activity with IO- tables, trade statistics, and industry statistics This requires combining industry-level data of bilateral MNE activity with IO- tables, trade statistics, and industry statistics We compile such a data-set for U.S. FAS in Western Europe We compile such a data-set for U.S. FAS in Western Europe

Conclusions There, one is tempted to expect H- interdependence to dominate (countries are similar; cost differences irrelevant; markets fairly integrated) There, one is tempted to expect H- interdependence to dominate (countries are similar; cost differences irrelevant; markets fairly integrated) V-interdependence is strongly supported by data but H-interdep. is not V-interdependence is strongly supported by data but H-interdep. is not Consistent with Bergstrand and Egger (08); outsourcing and components trade are Ethier-type (among DCs rather than DCs & LDCs) Consistent with Bergstrand and Egger (08); outsourcing and components trade are Ethier-type (among DCs rather than DCs & LDCs)