1. Firms, Location and Distance
Chapter 6

2. Distance in economics
The relevance of transportation costs (Table 6.1)
CIF (cost, insurance, freight)
FOB (free on board)
Empirical evidence (Hummels, 1999)
Shipping costs are higher in
countries located further away from major markets, and
landlocked countries.
Transport costs have not declined uniformly over time (costs of distant travel have declined relative to proximate travel).
Also see Box 6.1.

4. Figure 6.1 Ad valorem trade costs by exporting country, 2008 (%)
Source: based on data for 134 countries from Sourcin and Pomfret (2012).

5. Figure 6.2 Container port traffic; mn TEU (20-foot equivalent units), 2000-2010
Source: world bank development indicators online

7. Figure 6.3 Developments in world air transport freight; mn ton-km, 1975-2010
Source: world bank development indicators online

8. Figure 6.4 Home firm decision tree
Firm in Home
serve foreign markets / source from abroad? no
yes, source from abroad
yes, serve foreign market
Stay
domestic
Export or
local production?
Import or
local production?
export
import
local production
local production
Export
Multinational activity:
horizontal
Multinational activity:
vertical
Import
Figure 6.4

9. Simplifying assumptions
Firms can locate production in two (identical) countries.
Production uses only one input.
MCs in terms of labor are constant.
There are firm-specific fixed costs (F); related to knowledge capital. These costs are only imposed once.
Setting up a plant gives rise to plant-specific fixed costs (P).
Transportation costs (in terms of labor) are t per unit exported.
Markets are segmented (i.e., no risk of arbitrage).
Headquarters also use resources, which are covered by firm-specific fixed costs (F).

10. Figure 6.5 Profits in the Home and Foreign market: national exporting firm

11. Figure 6.6 Going multinational: the horizontal case

12. Figure 6.7 Going multinational: the vertical case

13. Hybrid cases
Combination of market seeking (horizontal) and efficiency and/or natural resource seeking (vertical) multinational activity.
Export platform multinational activity
Strategic asset seeking multinational activity

14. The Gravity Model of International Trade
Link between distance and trade
Introduces a spatial or geographical element.
If the two countries are large and are close to each other then bilateral trade (between them) will be large.
Is geography destiny?
The role of infrastructure and technology.
No center of production remains a center forever.

15. Liability of foreignness and multiple types of distance
Geographic distance
Cultural distance (also see box 6.3)
Economic distance
Institutional/legal distance

16. Figure 6.8 Geographic distance and foreign sales of US multinationals

17. Figure 6.9 Cultural distance and foreign sales of US multinationals

18. Figure 6.10 Institutional quality and foreign sales of US multinationals

19. Figure 6.11 Liability of foreignness for a horizontal multinational

20. supporting industries
Figure 6.12 Porter’s diamond model
Firm strategy,
structure, and rivalry
Demand
conditions
Factor
conditions
Figure 6.12
Related and
supporting industries

21. Dunning’s Ownership-Location-Internalization (OLI) Model
Dunning’s observation (in the 1950s) that
the US subsidiaries in the UK had higher
productivity relative to UK competitors.
Was the higher productivity due to higher efficiency by US managers regardless of location (ownership-specific effect) or due to superior resources of the US economy (importance of location).
But why do firms exploit their ownership-specific effect internally (internalization aspect, keeping foreign activities in house) instead of keeping these activities at arm’s length?

22. Outsourcing 3 main advantages of sub-contracting
Forgoing the plant specific fixed costs.
Cutting storage costs.
Access to experience and knowledge of the foreign firm.
Main disadvantage
Increased economic uncertainty due to dependence on the foreign partner and political and economic conditions in the partner’s country