Re-estimating the Knowledge-Capital Model: Evidence from Japanese and US Multinational Enterprises

This paper re-estimates the knowledge-capital model by James Markusen (2002) to study market access and factor endowment explanations of foreign direct investment (FDI). I add to the literature by combining consistent datasets on Japanese and U.S. multinational enterprises (MNE) in the period 1989-2002. To reduce potential bias, the prior specification of the knowledge-capital model is augmented with a number of additional control variables and estimated with a system GMM estimator. In the pooled sample, I find that both market access and relative skill endowments matter for the pattern of foreign affiliate sales. When separately estimating Japanese and US samples, the evidence shows that Japanese MNEs are encouraged by relative unskilled-labor abundance in a host country, consistent with a vertical motive of FDI. In contrast, U.S. MNEs concentrate on skill abundant countries, which is in favor of horizontal FDI. These findings imply that combining datasets on multinational activities with heterogeneous motives of FDI is critical for finding evidence of the knowledge-capital model.