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A Linder Hypothesis for Foreign Direct Investment

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

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.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8639.

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Date of creation: Nov 2011
Date of revision:
Handle: RePEc:cpr:ceprdp:8639
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  1. Ignatius J. Horstmann & James R. Markusen, 1990. "Endogenous Market Structures in International Trade," NBER Working Papers 3283, National Bureau of Economic Research, Inc.
  2. Pablo D. Fajgelbaum & Gene M. Grossman & Elhanan Helpman, 2009. "Income Distribution, Product Quality, and International Trade," NBER Working Papers 15329, National Bureau of Economic Research, Inc.
  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.
  4. 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.
  5. 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 244-50, May.
  6. S. Lael Brainard, 1993. "A Simple Theory of Multinational Corporations and Trade with a Trade-Off Between Proximity and Concentration," NBER Working Papers 4269, National Bureau of Economic Research, Inc.
  7. Markusen, James R, 1986. "Explaining the Volume of Trade: An Eclectic Approach," American Economic Review, American Economic Association, vol. 76(5), pages 1002-11, December.
  8. 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.
  9. 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.
  10. Natalia Ramondo & Andr�s Rodr�guez-Clare, 2013. "Trade, Multinational Production, and the Gains from Openness," Journal of Political Economy, University of Chicago Press, vol. 121(2), pages 273 - 322.
  11. 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.
  12. Hallak, Juan Carlos, 2006. "Product quality and the direction of trade," Journal of International Economics, Elsevier, vol. 68(1), pages 238-265, January.
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