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A Linder Hypothesis for Foreign Direct Investment

Author

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  • Fajgelbaum, Pablo
  • Grossman, Gene
  • Helpman, Elhanan

Abstract

We study patterns of FDI in a multi-country world economy. First, we present evidence for a broad sample of countries that firms direct FDI disproportionately to markets with income levels similar to their home market. Then we develop a model featuring non-homothetic preferences for quality and monopolistic competition in which specialization is purely demand-driven and the decision to serve foreign countries via exports or FDI depends on a proximity-concentration trade-off. We characterize the joint patterns of trade and FDI when countries differ in income distribution and size and show that FDI is more likely to occur between countries with similar per capita income levels. The model predicts a Linder Hypothesis for FDI, consistent with the patterns found in the data.

Suggested Citation

  • Fajgelbaum, Pablo & Grossman, Gene & Helpman, Elhanan, 2011. "A Linder Hypothesis for Foreign Direct Investment," CEPR Discussion Papers 8639, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:8639
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    References listed on IDEAS

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    1. Markusen, James R. & Venables, Anthony J., 2000. "The theory of endowment, intra-industry and multi-national trade," Journal of International Economics, Elsevier, vol. 52(2), pages 209-234, December.
    2. Pablo Fajgelbaum & Gene M. Grossman & Elhanan Helpman, 2011. "Income Distribution, Product Quality, and International Trade," Journal of Political Economy, University of Chicago Press, vol. 119(4), pages 721-765.
    3. Markusen, James R., 1984. "Multinationals, multi-plant economies, and the gains from trade," Journal of International Economics, Elsevier, vol. 16(3-4), pages 205-226, May.
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    5. Markusen, James R & Maskus, Keith E, 2002. "Discriminating among Alternative Theories of the Multinational Enterprise," Review of International Economics, Wiley Blackwell, vol. 10(4), pages 694-707, November.
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    7. Hallak, Juan Carlos, 2006. "Product quality and the direction of trade," Journal of International Economics, Elsevier, vol. 68(1), pages 238-265, January.
    8. Francois, Joseph F & Kaplan, Seth, 1996. "Aggregate Demand Shifts, Income Distribution, and the Linder Hypothesis," The Review of Economics and Statistics, MIT Press, vol. 78(2), pages 244-250, May.
    9. Juan Carlos Hallak & Peter K. Schott, 2011. "Estimating Cross-Country Differences in Product Quality," The Quarterly Journal of Economics, Oxford University Press, vol. 126(1), pages 417-474.
    10. Markusen, James R, 1986. "Explaining the Volume of Trade: An Eclectic Approach," American Economic Review, American Economic Association, vol. 76(5), pages 1002-1011, December.
    11. Juan Carlos Hallak, 2010. "A Product-Quality View of the Linder Hypothesis," The Review of Economics and Statistics, MIT Press, vol. 92(3), pages 453-466, August.
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    Cited by:

    1. Keith Head & Thierry Mayer, 2015. "Brands in Motion: How frictions shape multinational production," Working Papers 2015-26, CEPII research center.
    2. Hendrik W. Kruse, 2016. "Revisiting the Sectoral Linder Hypothesis: Aggregation Bias or Fixed Costs?," LIS Working papers 658, LIS Cross-National Data Center in Luxembourg.
    3. Sosa Andrés, Maximiliano & Nunnenkamp, Peter & Busse, Matthias, 2013. "What drives FDI from non-traditional sources? A comparative analysis of the determinants of bilateral FDI flows," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 7, pages 1-53.
    4. Eppinger, Peter S. & Kukharskyy, Bohdan, 2017. "Contracting institutions and firm boundaries," University of Tuebingen Working Papers in Economics and Finance 100, University of Tuebingen, Faculty of Economics and Social Sciences.
    5. Ramondo, Natalia & Rappoport, Veronica & Ruhl, Kim J., 2016. "Intrafirm trade and vertical fragmentation in U.S. multinational corporations," Journal of International Economics, Elsevier, vol. 98(C), pages 51-59.
    6. Aw, Bee Yan & Lee, Yi, 2014. "A model of demand, productivity and foreign location decision among Taiwanese firms," Journal of International Economics, Elsevier, vol. 92(2), pages 304-316.
    7. Aleksynska, Mariya & Havrylchyk, Olena, 2013. "FDI from the south: The role of institutional distance and natural resources," European Journal of Political Economy, Elsevier, vol. 29(C), pages 38-53.
    8. Claudia Bernasconi, 2013. "Similarity of income distributions and the extensive and intensive margin of bilateral trade flows," ECON - Working Papers 115, Department of Economics - University of Zurich.
    9. McCalman, Phillip & Spearot, Alan, 2013. "Why trucks jump: Offshoring and product characteristics," Journal of International Economics, Elsevier, vol. 91(1), pages 82-95.
    10. Thomas J. Holmes & Ellen R. McGrattan & Edward C. Prescott, 2015. "Quid Pro Quo: Technology Capital Transfers for Market Access in China," Review of Economic Studies, Oxford University Press, vol. 82(3), pages 1154-1193.
    11. Jørgen Drud Hansen & Virmantas Kvedaras & Jørgen Ulff-Møller Nielsen, 2015. "Creative destruction and export patterns," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 24(3), pages 373-394, April.

    More about this item

    Keywords

    FDI; monopolistic competition; multinational corporations; nested logit; product quality; trade; vertical specialization;

    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business

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