Vertical Specialization in Multinational Firms*

In the recent decades, growth of overall world trade has been driven in large part by the rapid growth of trade in intermediate inputs. This input trade results in part from multinational firms choosing to outsource input processing to their foreign affiliates, thereby creating global production networks in which each actor is vertically specialized. In this paper, we use firm-level data on U.S. multinationals to examine trade in intermediate inputs between parent firms and their foreign affiliates. We estimate affiliate demand for imported inputs as a function of host-country trade costs, factor prices, and other variables. Among our main findings are that affiliate demand for imported inputs for further processing decrease in direct proportion to host-country tariffs, host-country wages for less-skilled labor (both in absolute terms and relative to wages for more-skilled labor), and host-country corporate income tax rates. Consistent with recent theory, these results suggest that vertical specialization within multinational firms rises as trade barriers between countries fall and as factor-price differences between countries widen. *Email addresses: [email protected], [email protected], and [email protected]. For assistance with data we thank Bruce Blonigen, Fritz Foley, Jon Haveman, and James Rauch. For helpful comments we thank Doug Staiger. For financial support Hanson and Slaughter acknowledge the National Science Foundation. Views expressed in this paper are those of the authors and do not necessarily reflect those of the Bureau of Economic Analysis. The statistical analysis of firmlevel data on U.S. multinational companies reported in this study was conducted at the International Investment Division, U.S. Bureau of Economic Analysis, under arrangements that maintained legal confidentiality requirements.