Regional Trade Integration and Multinational Firm Strategies

This paper analyzes the e¤ects of the formation of a regional trade agreement on the level and nature of multinational …rm activity. We examine aggregate data that captures the response of U.S. multinational …rms to the formation of the ASEAN free trade agreement. Observed patterns guide the development of a model in which heterogeneous …rms from a source country decide how to serve two foreign markets. Following a reduction in tari¤s on trade between the two foreign countries, the model predicts growth in the number of source-country …rms engaging in foreign direct investment, growth in the size of a¢ liates that are active in reforming countries both before and after the tari¤ reduction, and an increase in the extent to which the sales of a¢ liates in reforming countries are directed towards other reforming countries. Analysis of …rm-level responses to the creation of the ASEAN free trade agreement yields results that are consistent with these predictions. Harvard University and NBER; Harvard Business School and NBER. This paper was prepared for the Workshop on “Quantifying the Costs and Bene…ts of Regional Economic Integration,”held on January 19-20, 2009 in Hong Kong. The statistical analysis of …rm-level data on U.S. multinational companies was conducted at the Bureau of Economic Analysis, U.S. Department of Commerce under arrangements that maintain legal con…dentiality requirements. The views expressed are those of the authors and do not re‡ect o¢ cial positions of the U.S. Department of Commerce. We are grateful to Eduardo Morales for superb research assistance and to Robert Barro, Elhanan Helpman, Jong-Wha Lee, Emanuel Ornelas, Bill Zeile, and seminar participants at Harvard and the Asian Development Bank for helpful suggestions.