The Proximity-Concentration Tradeoff Under Uncertainty

Abstract

This paper analyzes the firm's choice between serving a foreign market through exports or foreign affiliate sales in an environment characterized by country specic shocks to the cost of production. Our model predicts that country pairs with less correlated output fluctuations trade more, relative to affiliate sales, and countries with more volatile fluctuations are served relatively more by exporters than by foreign affiliates selling abroad. Using detailed data on trade and affiliate sales from the Bureau of Economic Analysis, we find empirical support for these predictions of the model.

Keywords: multinational production, country risk, proximity-concentration tradeoff

JEL Classification: F12, F23, F41