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Arm's-length transactions as a source of incomplete cross-border transmission: the case of autos

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  • Rebecca Hellerstein
  • Sofia Berto Villas-Boas

Abstract

A growing share of international trade occurs through intra-firm transactions-those 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 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 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 transaction 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 transactions than in multinational transactions because the higher markups from a double optimization along the distribution chain create more opportunity for markup adjustment following a shock. Since arm's-length transactions account for about 60 percent of U.S. imports, this difference may explain up to 20 percent of the incomplete transmission of foreign-cost shocks to the United States in the aggregate.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 251.

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Date of creation: 2006
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Handle: RePEc:fip:fednsr:251

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Related research

Keywords: International trade ; Business cycles ; Subsidiary corporations ; Industries ; Manufactures ; Retail trade ; Automobiles - Prices;

References

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Cited by:
  1. Fischer, Andreas M & Lutz, Matthias & Wälti, Manuel, 2007. "Who Prices Locally? Survey Evidence of Swiss Exporters," CEPR Discussion Papers 6442, C.E.P.R. Discussion Papers.
  2. Sofia Berto Villas-Boas, 2007. "Vertical Relationships between Manufacturers and Retailers: Inference with Limited Data," Review of Economic Studies, Oxford University Press, vol. 74(2), pages 625-652.

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