Multinational sales have grown at high rates over the last two decades, outpacing the remarkable expansion of trade in manufactures. Consequently, the trade literature has sought to incorporate the mode of foreign market access into the “new” trade theory. This literature recognizes that  rms can serve foreign buyers through a variety of channels: they can export their products to foreign customers, serve them through foreign subsidiaries, or license foreign  rms to produce their products. Our work focuses on the  rm’s choice between exports and “horizontal” foreign direct investment (FDI). Horizontal FDI refers to an investment in a foreign production facility that is designed to serve customers in the foreign market. Firms invest abroad when the gains from avoiding trade costs outweigh the costs of maintaining capacity in multiple markets. This is known as the proximity-concentration tradeoff. We introduce heterogeneous  rms into a simple multicountry, multisector model, in which  rms face a proximity-concentration trade-off. Every  rm decides whether to serve a foreign market, and whether to do so through exports or local subsidiary sales. These modes of market access have different relative costs: exporting involves lower  xed costs while FDI involves lower variable costs. Our model highlights the important role of within-sector  rm productivity differences in explaining the structure of international trade and investment. First, only the most productive  rms engage in foreign activities. This result mirrors other  ndings on  rm heterogeneity and trade; in particular, the results reported in Melitz (2003). Second, of those  rms that serve foreign markets, only the most productive engage in FDI. Third, FDI sales relative to exports are larger in sectors with more  rm heterogeneity. Using U.S. exports and af liate sales data that cover 52 manufacturing sectors and 38 countries, we show that cross-sectoral differences in  rm heterogeneity predict the composition of trade and investment in the manner suggested by our model. We construct several measures of  rm heterogeneity, using different data sources, and show that our results are robust across all these measures. In addition, we con rm the predictions of the proximityconcentration trade-off. That is,  rms tend to substitute FDI sales for exports when transport * Helpman: Department of Economics, Harvard University, Cambridge, MA 02138, Tel Aviv University, and CIAR (e-mail: ehelpman@harvard.edu); Melitz: Department of Economics, Harvard University, Cambridge, MA 02138, National Bureau of Economic Research, and Centre for Economic Policy Research (e-mail: mmelitz@ harvard.edu); Yeaple: Department of Economics, University of Pennsylvania, 3718 Locust Walk, Philadelphia, PA 19104, and National Bureau of Economic Research (e-mail: snyeapl2@ssc.upenn.edu). The statistical analysis of  rmlevel data on U.S. Multinational Corporations reported in this study was conducted at the International Investment Division, U.S. Bureau of Economic Analysis, under an arrangement that maintained legal con dentiality requirements. Views expressed are those of the authors and do not necessarily re ect those of the Bureau of Economic Analysis. Elhanan Helpman thanks the NSF for  nancial support. We also thank Daron Acemoglu, Roberto Rigobon, Yona Rubinstein, and Dani Tsiddon for comments on an earlier draft, and Man-Keung Tang for excellent research assistance. 1 See Wilfred J. Ethier (1986), Ignatius Horstmann and James R. Markusen (1987), and Ethier and Markusen (1996) for models that incorporate the licensing alternative. We therefore exclude “vertical” motives for FDI that involve fragmentation of production across countries. See Helpman (1984, 1985), Markusen (2002, Ch. 9), and Gordon H. Hanson et al. (2002) for treatments of this form of FDI. 3 See, for example, Horstmann and Markusen (1992), S. Lael Brainard (1993), and Markusen and Anthony J. Venables (2000). 4 See also Andrew B. Bernard et al. (2003) for an alternative theoretical model and Yeaple (2003a) for a model based on worker-skill heterogeneity. James R. Tybout (2003) surveys the recent micro-level evidence on trade that has motivated these theoretical models. 5 This result is loosely connected to the documented empirical pattern that foreign-owned af liates are more productive than domestically owned producers. See Mark E. Doms and J. Bradford Jensen (1998) for the United States and Sourafel Girma et al. (2002) for the United Kingdom.

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Export Versus FDI with Heterogeneous Firms

We reconcile trade theory with plant-level export behavior, extending the Ricardian model to accommodate many countries, geographic barriers, and imperfect competition. Our model captures qualitatively basic facts about U.S. plants: (i) productivity dispersion, (ii) higher productivity among exporters, (iii) the small fraction who export, (iv) the small fraction earned from exports among exporting plants, and (v) the size advantage of exporters. Fitting the model to bilateral trade among the United States and 46 major trade partners, we examine the impact of globalization and dollar appreciation on productivity, plant entry and exit, and labor turnover in U.S. manufacturing. (JEL F11, F17, O33)

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Plants and Productivity in International Trade

We develop a monopolistically competitive model of trade with firm heterogeneity—in terms of productivity differences—and endogenous differences in the “toughness” of competition across markets—in terms of the number and average productivity of competing firms. We analyse how these features vary across markets of different size that are not perfectly integrated through trade; we then study the effects of different trade liberalization policies. In our model, market size and trade affect the toughness of competition, which then feeds back into the selection of heterogeneous producers and exporters in that market. Aggregate productivity and average mark-ups thus respond to both the size of a market and the extent of its integration through trade (larger, more integrated markets exhibit higher productivity and lower mark-ups). Our model remains highly tractable, even when extended to a general framework with multiple asymmetric countries integrated to different extents through asymmetric trade costs. We believe this provides a useful modelling framework that is particularly well suited to the analysis of trade and regional integration policy scenarios in an environment with heterogeneous firms and endogenous mark-ups.

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Market Size, Trade, and Productivity

A simple model of process innovation is proposed, where firms learn about their ideal production process by making prototypes. We build around this a dynamic general equilibrium model, and derive conditions under which diversified and specialised cities coexist. New products are developed in diversified cities, trying processes borrowed from different activities. On finding their ideal process, firms switch to mass-production and relocate to specialised cities with lower costs. When in equilibrium, this configuration welfare-dominates those with only diversified or only specialised cities. We find strong evidence of this relocation pattern in establishment relocations across French employment areas 1993u1996.

Nursery Cities: Urban Diversity, Process Innovation and the Life-Cycle of Products

A rapidly expanding literature on firm heterogeneity and firm level globalisation strategies has developed over the last decade. There are new insights on why some firms export and others do not, why some firms fail to survive in export markets and some choose to produce overseas rather than export. This article provides a synthesis and evaluation of this literature. It reviews both new theories of firms in an open economy context and the extensive microeconometric evidence base, which has now developed. It highlights the implications of this evidence base for policy and includes an assessment of how the research agenda may evolve.

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Firm heterogeneity, exporting and foreign direct investment*

Research on the spatial aspects of economic activity has flourished over the past decade due to the emergence of new theory, new data, and an intense interest on the part of policymakers, especially in Europe but increasingly in North America and elsewhere as well. However, these efforts - collectively known as the "new economic geography" - have devoted little attention to the policy implications of the new theory. "Economic Geography and Public Policy" fills the gap by illustrating many new policy insights economic geography models can offer to the realm of theoretical policy analysis. Focusing primarily on trade policy, tax policy, and regional policy, Richard Baldwin and coauthors show how these models can be used to make sense of real-world situations. The book not only provides much fresh analysis but also synthesizes insights from the existing literature. The authors begin by presenting and analyzing the widest range of new economic geography models to date. From there, they proceed to examine previously unaddressed welfare and policy issues including, in separate sections, trade policy (unilateral, reciprocal, and preferential), tax policy (agglomeration with taxes and public goods, tax competition and agglomeration), and regional policy (infrastructure policies and the political economy of regional subsidies). A well-organized, engaging narrative that progresses smoothly from fundamentals to more complex material, "Economic Geography and Public Policy" is essential reading for graduate students, researchers, and policymakers seeking new approaches to spatial policy issues.

Economic Geography and Public Policy

A poorly understood empirical phenomenon is export-platform affiliate production (EP), particularly for sale in third countries rather than in the parent or host countries. We develop a three-region model, with two identical large, high-cost countries (collectively called North) and a small, low-cost country (South). The large countries each have one firm. Our theory section analyzes the conditions under which one or both of these firms uses the South to produce for (a) export back to the parent (home-country EP), (b) export to the other large country (third-country EP), or (c) export to both (global EP). A free-trade area between one of the northern countries and South can lead to the insider northern firm choosing home or global EP and the outsider firm choosing third-country EP for a range of parameter values. Our empirical section shows the relevance of this outcome. Foreign manufacturing affiliates of US multinationals inside North America concentrate on home-country EP while affiliates inside Europe concentrate on third-country EP. (JEL: F12, F23)

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Export-Platform Foreign Direct Investment

We develop an analytically solvable version of the central model of 'new economic geography', the so called core-periphery model by Krugman. While the modified model reproduces all the appealing features of the original one, it also allows us to obtain additional analytical results that are out of reach in Krugman's set-up. First, we are able to assess the exact number of equilibria and their global stability properties. Second, we are able to investigate the implications of exogenous asymmetries between countries. This is achieved by introducing heterogeneity between high-skill mobile and low-skill immobile workers, which may also be an empirically attractive property. Copyright 2003, Oxford University Press.

An analytically solvable core‐periphery model

We present a model where long-run growth and industrial location are jointly endogenous by introducing Romerian product innovation growth into Krugman’s core‐periphery model. We focus on stability, showing that growth is a powerful centripetal force, but that knowledge spillovers are a powerful centrifugal force. Integration policies that lower the cost of trading ideas are shown to encourage dispersion of economic activity while those that lower the cost of trading goods encourage agglomeration. Agglomeration is shown to be favourable to growth in both regions. The pro-growth effects mitigate the periphery’s static welfare loss from agglomeration.

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The Core-Periphery Model and Endogenous Growth: Stabilizing and Destabilizing Integration

Tax competition between two countries is considered in a trade- and-location setting with differentiated products and monopolistic competition. There are two groups of workers, mobile ones and immobile ones. Taxes are used for producing a public good. It is shown that an equilibrium with mobile workers dispersed across countries is destabilised by increased taxes on these mobile workers|and this is shown to be true also for perfectly coordinated tax increases. It is also shown that an agglomeration is taxable, and that increasing public spending may relax the minimum tax pressure on immobile workers consistent with preserv-ing an agglomeration.

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Rikard Forslid

Papers

Economic Geography and Public Policy

Export-Platform Foreign Direct Investment

An analytically solvable core‐periphery model

The Core-Periphery Model and Endogenous Growth: Stabilizing and Destabilizing Integration

Tax competition and economic geography