Affiliating versus Subcontracting: the Case of Multinationals

Abstract

An aspect of globalization that has attracted increased attention in recent years is intra-firm trade. Actually, an intra-firm trading relationship indicates that an affiliate is present in the partner country. Hence, distinguishing intra- and extra-firm dimensions gives us access to the boundaries of multinationals and consequently to their policies of development. More precisely, the paper aims at determining factors of the trade-off faced by multinationals between affiliating and subcontracting a relocated segment of production or distribution, using microdata on intra- and extra-firm bilateral trade of affiliates located in France. First, a microeconomic model is developed. The idea is to compare the profit made by a multinational if trade occurs within it with that made if trade occurs with another firm. On the one hand internalization may generate additive fixed costs, on the other it may enable the multinational to keep its comparative advantage gained through the development of firm-specific assets. The model is then empirically validated. The advertising intensity and the technological level of production are notably associated with intra-firm trade and thus with internalization. Actually, both brand and quality are shown to be profit accelerators in the event of affiliating. Essential means of product differentiation, these two factors are enough for multinationals to cover the additive fixed costs generated by internalization when the market becomes sufficiently large.boundaries of multinationals, intra-firm trade, product differentiation