The effects of multinational activities on the measurement of home bias

Foreign products reach domestic consumers via cross-border trade and by the production of foreign affiliates of multinational enterprises. The conventional measurement of home bias in consumption of national products relative to foreign products does not recognize the role of multinational activities. In this paper, a gravity-based model that accounts for trade and the operation of foreign affiliates as alternative channels of accessing foreign markets is derived. This gravity-based model is used to theoretically demonstrate that disregarding the activities of multinational enterprises leads to an upward bias in the measurement of home bias. Our empirical application is conducted on a subset of OECD countries in the manufacturing sector. The benchmark results indicate that home bias is overstated by a factor of 1.7 when disregarding the multinational activities. J. Japanese Int. Economies 22 (3) (2008) 401-416.