Tariff Effects on MNC Decisions to Engage in Intra-Firm and Arms-Length Trade

Using confidential firm level data from the Bureau of Economic Analysis (BEA) on activities of U.S. multinational corporations (MNCs) and their Canadian affiliates, we study the dramatic growth of intra-firm and arms-length U.S.-Canada trade over the 1984-1995 period. We find that the increase in trade occurred almost entirely on the intensive rather than the extensive margin. That is, MNC parents and affiliates that already engaged in intra-firm and arms-length trade in 1983 expanded trade dramatically, while very few firms commenced trade. We also find that decisions to engage in intra-firm and arms-length trade are essentially unrelated to tariff and transport cost reductions over this sample period. This is consistent with case study evidence in Keane and Feinberg (2005), where MNC executives consistently indicate that the modest tariff reductions of the ’84-’95 period were not sufficient to justify fixed costs of overhauling international supply chains. Our results have important implications for recent influential models of international trade that rely on sensitivity of intra-firm trade to tariffs at the extensive margin to explain how small tariff declines could have led to the explosion of intra-firm trade since the 80s. Our results here and in Keane and Feinberg (2005) suggest that the real reason for the growth of intra-firm trade is not tariff reductions but rather the adoption of just-in-time logistics, which has substantially reduced the inventory carrying cost of intra-firm trade. Acknowledgements: The statistical analysis of the confidential firm-level data on U.S. multinational corporations reported in this study was conducted at the International Investment Division, Bureau of Economic Analysis, U.S. Department of Commerce, under arrangements that maintained legal confidentiality requirements. The views expressed are those of the authors and do not necessarily reflect those of the Department of Commerce.