Ebook Investment Liberalization and the Geography of Firm Location
The theory of international trade with increasing returns to scale and imperfect competition in production includes analyses of firm location and industry agglomeration that are sometimes referred to as “economic geography”. With increasing returns and interdependencies among firms, parameter changes in trade costs can have interesting and indeed non-monotonic effects on industry location patterns. The recent works by Fujita, Krugman, and Venables (1999), Brackman et. al. (2001), and Baldwin et. al. (2003) present a great deal of research in this interesting and important new sub-field.
One limitation of this location literature is that it almost exclusively deals with geographically integrated firms that conduct all activities from R&D to final production in a single location. But when we examine the industries which motivate this literature, we generally find them dominated by multinational firms. A parallel literature to the economic geography approach considers the endogenous formation of multinational firms. Much of it reflected in Markusen’s (1997, 2002) “knowledge-capital” model. Firms’ location strategies include not just where to located an integrated operation, but include horizontal expansion, producing roughly the same goods and services in multiple locations, and/or vertical strategies in which the production process is geographically fragmented into stages such as R&D, component production, and final assembly.
There are now a few relatively new papers which integrate some the new-geography models with the multinational models. Important contributions include Barry (1996), Gao (1999), Raybaudi-Massilia (2000), and Ekholm and Forslid (2001), and Egger et. al. (2005). Much of this work concentrates on the question of how changes in trade costs affect location decision when multinational firms form endogenously versus when they are not allowed (the geography models), and/or the consequences of factor mobility with and without multinationals. They tend to have a particular focus on multiple and unstable equilibria in the geography tradition.
This paper continues in the tradition of the research just discussed, trying to integrate results from the geography and multinationals models. We use the world Edgeworth box to consider a series of two-country cases in which the countries differ in size and/or in relative endowments. We use Markusen’s knowledge-capital model in which firms may adopt national, horizontal, or vertical strategies. Second, instead of focusing on trade costs and/or factor mobility, we will focus on investment barriers and the effect of removal of investment barriers on the location of activities holding trade costs constant and factors immobile. The location of firm “headquarters” (R&D, management, marketing, finance and so forth) may change in ways quite different from the location and number of production plants.
The model is a two-good, two-factor, two-country general equilibrium model where the X sector has increasing returns and imperfect competition. An X firm is associated with a country where its headquarters is located. If it has a single plant in that same country, it is referred to as a national firm (type-n). If it has plants in both countries, it is referred to as a horizontal multinational (type-m). If its single plant is in the non-headquarters country, then it is referred to as a vertical multinational (type-v). These three firm types can be headquartered in either country, giving a total of six firm types in all.
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