Multinational production and comparative advantage

Abstract

This paper shows analytically and quantitatively how omitting the striking sectoral heterogeneity of multinational production (MP) and its relationship with countries' comparative advantage leads to understate the gains from MP and openness. By construction, one-sector models of trade and MP, ignore the conflicting effects that a reduction in MP frictions has on the sectoral dispersion of MP and trade shares. On the one hand, freer MP increases the dispersion of MP shares across sectors, and with it, the gains from MP. On the other hand, it reduces the heterogeneity of trade shares, since MP erodes sectoral level Ricardian comparative advantage, diminishing therefore gains from trade. These effects are driven by the disproportional allocation of MP in industries where local firms are relatively less productive, which generates an uneven productivity boost favoring comparative disadvantage sectors, lowering the differences in observed sectoral productivities. To assess the welfare implications of this mechanism, this paper assembles a novel industry-level dataset of bilateral foreign affiliate sales for 32 countries, 9 tradable sectors and 4 non-tradeble sectors.