Vertical Production Networks in Multinational Firms*

In recent decades, growth of overall world trade has been driven in large part by the rapid growth of trade in intermediate inputs. Much of this input trade involves multinational firms locating input processing in their foreign affiliates, thereby creating global vertical production networks. In this paper, we use firm-level data on U.S. multinationals to examine trade in intermediate inputs for further processing between parent firms and their foreign affiliates. We estimate affiliate demand for imported inputs as a function of host-country and industry trade costs, factor prices, and other variables. Among our main findings are that demand for imported inputs is higher when affiliates face lower trade costs, lower wages for lessskilled labor (both in absolute terms and relative to wages for more-skilled labor), and lower corporate income tax rates. These results contrast with many findings in previous research. *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 David Belli, Lael Brainard, Fritz Foley, Ann Harrison, Jim Hines, Ned Howenstine, Tom Hubbard, Jorg Mayer, Peter Merrill, Richard Sansing, Doug Staiger, Adrian Tschoegl, Obie Whichard, William Zeile and conference and seminar participants at the American Economics Association, the Brookings Institution and International Tax Policy Forum, Erasmus University, the Federal Reserve Board, the London School of Economics, the National Bureau of Economic Research, Stanford University, the U.S. Bureau of Economic Analysis, University of Chicago Graduate School of Business, the Wharton School, and Yale University. For financial support Hanson and Slaughter gratefully 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 firm-level 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.