Intrafirm and Arm’s-Length Trade: How Distance Matters

Abstract

Multinational and exporting firms play a key role in trade patterns. To highlight the importance of intra-firm trade in share of world trade, this paper develops a model of trade and intra-firm trade with heterogeneous firms. In this set up, trade costs apply to both exports and multinational production because both involve transportation. However, the magnitude will differ. The introduction of intra-firm trade generates a complementarity between FDI and Exports. Using data for 1999-2004, we test the gravity equations delivered by the model. Quantitatively, we find that exports within the boundaries of the firms are less sensitive to geographical barriers than arm's length trade.