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Arm's-Length Transactions as a Source of Incomplete Cross-Border Transmission: The Case of Autos

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Author Info
Rebecca Hellerstein (Federal Reserve Bank of New York)
Sofia Villas-Boas (University of California, Berkeley)

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Abstract

A growing share of international trade occurs through intra-firm transactions between domestic and foreign subsidiaries of a multinational firm. The difficulties associated with writing and enforcing a vertical contract compound when a product must cross a national border, and may explain the high rate of multinational trade across such borders. We show that this common cross-border organization of the firm may have implications for the well-documented incomplete transmission of shocks across such borders. We present new evidence of a positive relationship between an industry's share of multinational trade and its rate of exchange-rate pass-through to prices. We then develop a structural econometric model with both manufacturers and retailers to quantify how firms' organization of their activities across national borders affects their pass-through of a foreign cost shock. We apply the model to data from the auto market. Counterfactual experiments show why cross-border transmission may be much higher for a multinational than for an arm's-length transaction. In the structural model, firms' pass-through of foreign cost shocks is on average 29 percentage points lower in arm's-length than in multinational transactions, as the higher markups from a double optimization along the distribution chain create more opportunity for markup adjustment following a shock. As arm's-length transactions account for about 60 percent of U.S. imports, this difference may explain roughly 20 percent of the incomplete transmission of foreign-cost shocks to the U.S. in the aggregate.

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Paper provided by Department of Agricultural & Resource Economics, UC Berkeley in its series Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series with number 1016.

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Date of creation: 13 Mar 2006
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Handle: RePEc:cdl:agrebk:1016

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Related research
Keywords: Cross-border transmission; Multinationals; Arm's-length transactions; Real exchange rates; Exchange-rate pass-through; Vertical contracts; Autos;

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Andreas M. Fischer & Matthias Lutz & Manueal Wälti, 2007. "Who Prices Locally? Survey Evidence of Swiss Exporters," University of St. Gallen Department of Economics working paper series 2007 2007-39, Department of Economics, University of St. Gallen. [Downloadable!]
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