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Exports versus multinational production under nominal uncertainty

Listed author(s):
  • Logan T. Lewis

This paper examines how nominal uncertainty affects the choice firms face to serve a foreign market through exports or to produce abroad as a multinational. I develop a two-country, stochastic general equilibrium model in which firms make production and pricing decisions in advance, and I consider its implications on this relative choice. For foreign firms, both exports and multinational production are priced in the destination currency, and this uncertainty has no effect on the relative decision. In the data, U.S. firms set nearly all of their export prices in dollars. Therefore, home firms price exports in their own currency in the model. Home exporters gain an advantage over home multinationals: during a foreign contraction, the foreign exchange rate appreciates, causing exported goods from the home country to be relatively cheaper. This pricing advantage affects exporters non-linearly through demand, which translates to convex profits. As foreign volatility rises, the model implies that the home country should serve the foreign country relatively more through exports. I take this implication to bilateral U.S. data, using inflation volatility as a proxy for nominal volatility. Using sectoral data on sales by majority-owned foreign affiliates matched with U.S. exports, I find that higher inflation volatility is associated with a significantly lower ratio of multinational production to total foreign sales.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 1038.

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Date of creation: 2011
Handle: RePEc:fip:fedgif:1038
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