Accounting for the Growth of Mnc-Based Trade Using a Structural Model of U.S. Mncs

U.S. foreign trade has grown much more rapidly than GDP in recent decades. But there is no consensus as to why. More than half of U.S. foreign trade consists of arms-length and intra-firm trade activity by multinational corporations (MNCs). Thus, in order to better understand the growth of trade, it is important to understand the reasons for the rapid growth in MNC-based trade. This paper uses confidential BEA data on the activities of U.S. MNCs to shed light on this issue. Specifically, we estimate a simple structural model of the production and trade decisions of U.S. MNCs with affiliates in Canada, the largest trading partner of the U.S., using data from 1983-96. We then use the model as a framework to decompose the growth in intra-firm and arms-length trade flows into components due to tariff reductions, changes in technology, changes in wages, and other factors. We find that tariff reductions can account for a substantial part of the increase in arms-length MNC-based trade. But our model attributes most of the growth of intra-firm trade to technical change, with tariff reductions playing only a secondary role. Simple descriptive statistics provide face validity for this result, since arms-length trade grew much more rapidly in industries with the largest tariff reductions, while intra-firm trade grew rapidly even in industries where tariffs were negligible to begin with. Our work makes a number of other contributions: Our descriptive analysis of the BEA firm level data, which has rarely been made available for research, suggests that few MNCs fit into the neat vertical vs. horizontal dichotomy of the theoretical literature. Also, we find that MNC decisions to engage in intra-firm and arms-length trade are unrelated to tariff levels. The growth in MNC-based trade due to tariff reductions has been almost entirely on the intensive margin, among the subset of firms already engaged in such activities. Finally, the estimation of our model requires the development of a number of new econometric procedures. We present new recursive importance sampling algorithms that are the continuous and discrete/continuous analogues of the GHK method