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Summary FDI Material Week 4 - Monopolistic competition
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Lecture 4, Helpman et al. (2004), and Chen & Moore (2010)
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Lecture 4September 27, 2022 11:01 AM
Title: Monopolistic competition: FDI and firm heterogeneity (Horizontal FDI)
Y were new and new- • Standard trade models do not fully explain contemporary trade
new trade theories
developed? • Looking for different trade theories: imperfect competition; firm heterogeneity
• Standard trade models:
W motivates trade
acc. to Ricardo and • International trade (and investments?) could be driven by comparative
HO? advantages of the home country: factor abundance (HO) or better technology
(Ricardo)…
• Helpman's imperfect (monopolistic) competition: not all products are the same
W motivates trade and we like to buy some of each
acc. to Helpman? ○ Firms get “quasi-monopolist” power: price somewhat higher than
WR the gains from marginal costs – Firms make a bit of operating profit
trade acc. to ○ Gains from trade:
Helpman? ▪ specialization into productive industries: lower costs
WI a key assumption ▪ Love of variety: more utility from variety
in new TT? ○ Key assumption: homogenous firms
D empirical data • Empirical findings: firm heterogeneity
support this • Only a minority export (Bernard: extensive margin of trade) and from those,
assumption? only a few does the bulk of exports (Bernard: intensive margin of trade)
• Trade w/ firm heterogeneity:
HR exporters • Exporters are different:
different?
○ Higher productivity
○ Higher employment
○ Higher wages
HR firms that do FDI • Firms that do FDI rank higher in these three categories…
different? ○ Intuition: only the most productive firms export, and the most productive
exporters can engage in FDI.
WR the gains from • Gains from trade: countries (not firms) become more productive on average
trade acc. to Melitz? ○ Reallocation of resources to more productive firms, though their firm
D firm productivity
change acc. Melitz? productivity does not change
• FDI can be substitute or complement of trade:
HC FDI be both a
substitute and a • Substitute: Horizontal FDI
complement to trade? ○ Today we talk about horizontal FDI!
• Complement: Vertical FDI
• New-new trade theory uses the same model to understand FDI:
HD new-new TT extend • Goal: compare export vs horizontal(!) FDI option
the model to
understand FDI? • Goods are imperfect substitutes (monopolistic competition)
• Different Marginal costs mc (=proxy for firm productivity)
WD Melitz assume • Fixed costs of production (= decreasing slope AC curve = increasing returns to
about…
*Substitutability? scale)
*Entry/exit? • Exporting implies transport costs , which are 'iceberg costs'
*returns to scale? • FDI takes additional fixed costs (= plant level costs P)
*transport costs?
*costs faced by firms • Firm:
with different ○ Always produces for home market
strategies?
○ Producing for foreign market implies a larger costs
○ FDI implies that my average cost level changes (because it has plant costs
but not transport costs)
FDI Page 37
,Graph individual
firm's production
function (incl. D,
AC, MC, MR, P, Q, ○
profit) for domestic
and foreign (export &
FDI) operations…
▪ To see if it makes sense to open an FDI (horizontal), C+D has to be
When does a firm find
larger than A+B
it profitable to open □ C should be identical to A, as at home nothing changed
a foreign affiliate? The change is D vs B as trade costs are not present but
(refer to profit as
illustrated in
now we have to pay fixed costs in a plant abroad
production function □ 'proximity-concentration' trade off:
graphs) Proximity: it is better to be as close as possible to the
final consumer because you do not have to pay trade
WI the proximity- costs
concentration trade- Concentration: the most concentrated the production,
off?
the easier it is to access economies of scale
○
• Helpman et al. (2004) in 3 steps
1. Introduce model: domestic/export/FDI sequence and link to individual firm
productivity (= Figure 1 paper). Firms are ordered by their productivity, for
which they are categorized as:
HR firms ordered in ○ Exit: least productive cannot cover the costs of producing.
HMY (2004)? Which
activities does each ○ Domestic: productive firms can survive and produce domestically.
perform? ○ Export: MNE can profitably export, but building a plant is even more
(graph profit profitable.
functions)
○ FDI: the most productive exporters can profitably engage in horizontal FDI
○
FDI Page 38
, ○ Empirical data (Helpman) show that in the US & BE this theory holds
2. Testable model: sales of firms (export/FDI) depend on key firm variables (and
HD HMY test this crucially on firm heterogeneity) (=equation 11)
theory empirically? ○ Dependent variable: (Sales per sector for US exports to country j) relative
to (US affiliate sales in country j) is dependent variable
WI the dependent
variable? ○ Key independent variables (at sectoral level):
▪ Transport costs between US and country j
WR the key □ variables: FREIGHT, TARIFF
independent
variables? (think ▪ Fixed costs (for exporting and at plant level)
about the trade-off □ variables: FP
and heterogeneity) ▪ A measure of firm heterogeneity (use the size distribution of firms
in each sector)
□ Variable: DISPERSE
□ The flatter the line in firm size distribution, the larger the
HD HMY account for difference between observed firms .
firm heterogeneity? Key variable!
Y size and not If size is correlated with productivity, the larger the
productivity dispersion in terms of size (~productivity), the higher
directly? the odds that there is more FDI in the industry.
◊ More FDI should be occurring in Drugs than in
In which industries Rubber/printing.
do they predict that ◊ Empirical evidence confirms this (see step 3
more FDI would
happen? below)!
□
3. Measuring variables (e.g. Figure 2) and testing model (e.g.: Table 3)
WR the main findings
of HMY (2004)?
○
• 2nd paper (Chen & Moore, 2010) focuses on the fact that not only firms are
HD Chen & Moore heterogeneous (in line with Melitz) but also countries are heterogeneous
refine HMY (2004)? • The model used by Chen & Moore is basically the same as in Helpman et al.
(2004) but with an adjustment suggested by Eaton (2008) to account for a
HD the model differ destination-firm specific demand parameter ( )
from HMY to achieve ○ The one big difference: differentials in firm productivity are now linked
this refinement?
with heterogeneous host-countries for FDI!
FDI Page 39
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