Edited by Lorraine Eden and Wendy Dobson
Chapter 7: Factor Price Differences and Multinational Activity
7. Factor price diﬀerences and multinational activity Ignatius J. Horstmann and Daniel R. Vincent INTRODUCTION In recent years there has been a growing trend among North American manufacturers toward outsourcing various parts of the production process either to independent domestic producers or foreign producers and subsidiaries. The presumption is that such outsourcing reﬂects the manufacturer’s taking advantage of lower cost production alternatives, often resulting from lower labor costs. Industries such as footwear, textiles, automobiles, electronics and computer software are often-cited examples of cases in which lower cost labor in developing countries is substituted for more expensive developed country labor. This somewhat casual empiricism is supported by Brainard (1997), who reports that the cross-country pattern of sales by foreign multinational aﬃliates back to the parent country is consistent with an explanation based on cross-country diﬀerences in relative factor endowments/factor prices. Brainard also points out, however, that in 1989 aﬃliate sales back to the parent country accounted for only 13 per cent of foreign aﬃliate production in the United States and between 2 per cent and 8 per cent of US aﬃliate production in other countries. For the remainder of multinational activity in Brainard’s study, a factor endowment/factor price diﬀerences explanation receives little support. There are two reasons. First, models of multinational activity based on factor diﬀerences (models of vertical multinationals, as Helpman, 1984, 1985) predict that multinational activity occurs between countries with large diﬀerences in relative factor endowments. The data reveal...
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