Multinationals, intra-firm trade and FDI: A simple model

This paper models trade and FDI in a world consisting of two symmetric countries. Using a monopolistic competition model of international trade which includes positive trade costs and endogenous multinational firms, we introduce an intermediate good and allow firms to fragment production internationally. The result is that under certain conditions, identical countries engage in both intra-industry FDI and intra-industry, intra-firm trade. This result provides a theoretical explanation for a well-observed but little explained phenomenon in the overlap between the theory of international trade and the theory of multinational enterprises. Examination of welfare demonstrates that firms make location choices that happen to maximise consumer welfare.