1. 2008-5-1VERC Conference,WLU,Canada1 Location Choices of the Pharmaceutical Industry in Europe after 1992 Prof. Frances P. Ruane The Economic and Social Research Institute, Ireland and The Institute for International Integration Studies, Trinity College Dublin, Ireland Xiaoheng Zhang The Institute for International Integration Studies and the Department of Economics, Trinity College Dublin, Ireland

2. 2008-5-1VERC Conference,WLU,Canada2 The Single Market Programme (1st, January, 1993) removed the non-tariff barriers between EU Member States to allow free movement of goods, capital, people and services. Multinationals rationalize their production by consolidating production facilities within a country or across countries to fully utilize economies of scale. Pharmaceuticals become a focus because it is an important industry to the EU economy and European people. We expect its significant response to the Single Market because this industry is able to benefit a lot from rationlization due to high increasing returns to scale. Context

3. 2008-5-1VERC Conference,WLU,Canada3 Measure the geographic concentration of pharmaceutical production across 14 EU countries using Theil Index and Location Gini coefficient (1993 to 2002) - Data source: OECD STructural ANalysis (STAN) database Pharmaceutical production and employment at country level where is the production in country i in the country set that under investigation, and n is the number of countries. Location Gini coefficient of concentration is defined as the area between the Lorenz curve and 45 degree line in a space where, the pharmaceutical production share of country i in the data set that under investigation, is cumulated on the Y-axis and the number of countries cumulated on the X-axis with equal interval of width 1/N. Countries are ranked by. Geographic Concentration Trend

4. 2008-5-1VERC Conference,WLU,Canada4 Theil Indices of Geographic Concentration of Pharmaceutical Production EU15 (OECD STAN data, EU 15, exclude Luxembourg)

5. 2008-5-1VERC Conference,WLU,Canada5 Location Gini coefficient (OECD STAN data, EU 15, exclude Luxembourg)

6. 2008-5-1VERC Conference,WLU,Canada6 New Economic Geography (NEG) theories Theories to analyse the spatial distribution of the economic activities between two or more regions. The subject is increasing returns to scale industry. Krugman (1991), Venables (1996), Baldwin (1997), Baldwin (2002), Puga (1999) Two different predictions on the relationship between trade costs and agglomeration. Theoretical explanations of the agglomeration/dispersion

7. 2008-5-1VERC Conference,WLU,Canada7 Krugman (1991): Monotonic relationship Puga (1999): Bell-shaped curve X-axis: trades costs level Y-axis: share of the industry in each of two regions

8. 2008-5-1VERC Conference,WLU,Canada8 Dispersion trend in the pharmaceutical industry and low trade cost imply that the agglomeration process of this industry may be at the left half of the Bell-shaped curve: high wages and congestion in the agglomerated region drive the industry to the less agglomerated regions. Empirical question - What are the determinants of pharmaceutical multinationals’ location choice? - Main focuses Country level agglomeration Corporate tax rate Market size Implication to the EU Single Market and the Pharmaceutical industry

9. 2008-5-1VERC Conference,WLU,Canada9 A Discrete-choice Framework (I) Multinationals choose a country from a set of alternative countries to expand their production or build up new facilities. Selected country is supposed to be able to maximize the multinational’s profit. Profit depends on the observable attribute of the alternative countries. The Conditional Logit Model (CLM) McFadden (1974)

10. 2008-5-1VERC Conference,WLU,Canada10 The problems with CLM - Simple but restrictive assumption on error term  The ratio of probabilities of any two alternatives being chosen is independent on any other alternatives. This is called “Independence from Irrelevant Alternatives” (IIA).  Individual taste behaves as an individual effect  correlation between error terms of alternatives  violation of IIA and inconsistent ML estimation - Not able to accommodate complicated individual structure in our case : several location choices made by the same MNE

11. 2008-5-1VERC Conference,WLU,Canada11 A discrete-choice framework (II) The Mixed Logit Model (MXL) Train (2003) Rabe-Hesketh et al. (2004) - Coefficient follows a normal distribution (random effect) - Control for MNE parent-Subsidiaries hierarchy

12. 2008-5-1VERC Conference,WLU,Canada12 Data Subjects: Pharmaceutical MNEs’ subsidiaries in 11 out of EU15 countries Data source: Amadeus data – Collection of European firm’s accounts Samples: High-performance sample – 224 existing pharmaceutical firms experiencing above-median expansion of turnover b/w 1995 and 2003 New firms sample – 119 firms that were established after 1993

13. 2008-5-1VERC Conference,WLU,Canada13 Major Explanatory Variables VariableDescriptionExpected signSource PHAR/ PHAR2 Absolute agglomeration of pharmaceutical production in each country. Number of employees / Gross output. ?OECD STAN PHARS- HARE/PH AR2SHARE Relative agglomeration of pharmaceutical production. The shares of one country’s pharmaceutical production to its total manufacturing production. ?OECD STAN Similar variables for the Chemical industry. +OECD STAN CDRUG Market size - National consumption of drugs and medicines. + OECD Health Data EATR National effective average tax rate (per cent) created by Devereux and Griffith (2003). - The Institute for Fiscal Studies LCOST National labour compensation per worker in the pharmaceutical industry (euros). -OECD STAN EDU3 Education level - National share of workers with a tertiary level education in manufacturing workforce (per cent). +Eurostat GOV The Governance indicator. +World Bank FAM Dummy variable =1 if for a firm, there are at least one other firm from the same MNE existed in a country, or a firm is located in the same country with the parent company. +The Amadeus

14. 2008-5-1VERC Conference,WLU,Canada14 Empirical Models High-performance Sample New-firm Sample For both CLM and MXL. Only agglomeration variables, tax rate and market size are treated as random-effect variables.

15. 2008-5-1VERC Conference,WLU,Canada15 Effective tax rate, market size, agglomeration of the pharmaceutical industry matter. Firm heterogeneity shows up through interaction terms. Hausman test rejects IIA for Germany, Portugal, Spain and Sweden if they are excluded. CLM and MXL show similar results. Results – High-performance Sample CLMMXL lnPHAR -1.225**-1.306** lnCHEM -0.508-0.506 lnCDRUG 1.638***1.757*** EATR -0.083***-0.099*** lnDIST 0.296*0.301* lnLCOST 1.444*1.372 EDU3 0.041**0.040** lnGOV -1.406**-1.355** EU Parent Prefer less agglomerated countries, and low labour costs N/A US ParentNo particular effects N/A Top MNEsLess prefer high education level N/A SizeEffects are very weak N/A Log- likelihood -437.0826-436.7510

16. 2008-5-1VERC Conference,WLU,Canada16 Results – New-firm Sample Only distance to Brussels and familiarity matter. Firm heterogeneity isn’t found. Hausman test cannot rejects IIA CLM and MXL show similar results. CLMMXL lnPHAR 0.4280.375 lnCHEM 0.499-0.381 lnCDRUG -0.394-0.304 EATR -0.018-0.020 lnDIST -1.103**-0.956* lnLCOST -1.282-0.630 EDU3 0.0410.055 COMP -0.013-0.014 lnGOV -0.700-1.034 FAM 1.008***1.004*** EU ParentNo particular effectsN/A US ParentNo particular effectsN/A Top MNEsNo particular effectsN/A SizeNo particular effectsN/A Log- likelihood -227.3379-226.9356

17. 2008-5-1VERC Conference,WLU,Canada17 Future Improvement Endogeneity in estimation of High-performance sample Petrin and Train (2002) a control function approach Lewbel (2004) “very exogenous variable” approach Adding variables to the models to test the assumptions of NEG models Krugman’s assumption : inter-region labour mobility  use skilled pharma workers in neighbouring countries to proxy potential labour flow Venerable/Puga’s assumption : intra-region labour mobility  use workers in Chemical industry in the same country to proxy potential intra-region labour flow

18. 2008-5-1VERC Conference,WLU,Canada18 Evidence is found to support Puga and Venables models of a non-monotonic relationship between industrial agglomeration and trade costs. The expansion in production at existing plants in Europe may contribute to Europe-level geographic dispersion of pharmaceutical production. The use of the conditional logit model in this research is justified by comparing its performance with those of the mixed logit models. Any comments and critiques are welcome! Conclusions