Foreign Direct Investment and Markups

This study investigates the effect of foreign direct investment (FDI) on markups using parent-foreign subsidiary matched data on Japan from 1997 to 2018. Using the cost of goods sold (COGS) as a measure of expenditure on variable inputs, we find that for manufacturing firms, the parent firm increases markups as the ratio of sales of foreign subsidiaries to those of the parent firm (i.e., the intensive margin of FDI) increases, while the parent firm does not significantly change markups in response to the FDI status (i.e., the extensive margin). We also find that the average markup of the corporate group, i.e., the weighted average of the markups charged by the parent firm and foreign subsidiaries, increases with both the extensive and intensive margins of FDI for manufacturing firms. Finally, we find that if we divide the host countries into developed and developing economies, a positive effect on markups is mainly observed for FDI to developing economies. Overall, our results suggest that firms increase markups by increasing vertical FDI.