How US corporations structure their international production chains

Natalia Ramondo, Veronica Rappoport, Kim Ruhl

The global nature of supply chains has rapidly come to dominate international trade. This column presents new evidence on production fragmentation and intra-firm trade. For US corporations, cross-country shipments of goods between units of the corporation are rare, despite the fact that most US manufacturing parents own foreign affiliates in upstream or downstream industries.

In 1997, the chipmaker Intel invested $330 million to build an assembly and test plant near Rio Segundo, Costa Rica. This plant assembled parts produced mostly by other Intel-owned affiliates. By 2006, Intel employed 3,500 workers and was responsible for almost 5% of total Costa Rican GDP and 20% of its exports (CEFSA 2006).

At about the same time, Apple began contracting with Taiwanese firm Hon Hai Precision Industry Co. – better known as Foxconn – to assemble Apple products out of parts produced almost entirely outside of Apple. In 2013, almost one third of Foxconn’s one million Chinese employees worked solely on producing the iPhone 5s.

Both Intel and Apple created these arrangements to take advantage of cost savings abroad, but they did so in very different ways. Intel created a wholly owned subsidiary, while Apple contracted ‘at arm’s length’ with an unaffiliated party. The cross-country production fragmentation embodied in these relationships – the global supply chain – has rapidly grown to the point that it now dominates international trade (Johnson and Noguera 2012). How are these supply chains structured?

In principle, these global supply chains can exist inside or outside the firm. In recent research using affiliate-level data on the activities of US multinational corporations from the Bureau of Economic Analysis (BEA), we document that the case of Intel is exceptional among the US multinational corporations in manufacturing (Ramondo et al. 2015). Cross-country fragmentation of production within the boundaries of the firm, with the purpose of providing goods to other parts of the firm, is not the norm.

New evidence on intra-firm trade and production fragmentation

Fact 1: Trade within US corporations is relatively rare.

The median affiliate ships nothing to – and receives nothing from – its US parent. Only 10% of the foreign affiliates of US multinationals are exclusively dedicated to providing goods to the rest of the corporation, while more than half of them ship less than 10% of their output to other members of the corporation. This is evident from Figure 1, in which we plot the histogram of US manufacturing affiliates by the share of their total sales shipped to affiliated parties. Most affiliates of multinational firms appear to exist with the purpose of serving consumers, or other firms, in their markets of operation. The concentration of intra-firm trade in a few affiliates is even more apparent in Figure 2 – 5% of the foreign affiliates of US multinationals account for three quarters of the total intra-firm trade observed in the data.

Figure 1. Distribution of affiliates by share of total sales shipped to affiliated parties

Fact 2: Independent of the size of their host markets, those affiliates that do ship goods within the firm tend to be large – such as Intel’s massive investment in tiny Costa Rica – and are often the largest affiliates within the corporation.

In fact, affiliates that trade with their parents employ, on average, twice as many workers as those that do not, while the largest 5% of foreign affiliates accounts for half of the total parent-affiliate trade recorded at the Bureau of Economic Analysis. The skewness of intra-corporation trade towards large affiliates is reminiscent of the skewness of manufacturing exports in large firms (Bernard and Jensen 1995) and of multinational activity in even larger firms (Helpman et al. 2004). The concentration of intra-firm trade in the largest firms is consistent with Antras and Helpman’s (2004) contract theory of the multinational firm, in which only the largest firms choose to keep offshore activities within the firm.

Fact 3: Though most parents own affiliates in upstream and downstream industries, the striking fact is that we find no relationship between the parent and the affiliate industries’ input-output relationship and intra-firm trade.

In our research, we document this regularity using the input-output table. This table shows, for example, that firms in the ‘agricultural chemicals’ industry use goods from the ‘pharmaceutical industry’ as inputs. Thus, it is natural to expect that an affiliate in the pharmaceutical industry owned by a parent in the agricultural chemical industry would ship goods to its parent – this is what the classical theory of the boundaries of the firm would predict. The data show that even though the overwhelming majority of affiliates are in industries tightly linked by an input-output relationship to their parent’s industries – a fact also documented in Alfaro and Charlton (2009) – we find no significant relationship between the flow of goods between members of the multinational corporation and the input-output links between them.

Figure 2. Distribution of affiliate’s trade to affiliated parties

Using data on multi-plant firms within the US, Atalay et al. (2014) also find a lack of trade between upstream and downstream plants within the firm. Our finding is even more surprising given that factor price differences – the theoretical motivation for production fragmentation and the intra-firm trade that accompanies it – are much larger across countries than across US cities.

Interpretation of findings and challenges

Our findings raise the obvious question: Why do multinational corporations own facilities in industries with strong input-output relationships, if not for the shipment of goods along the production chain? As Atalay et al. (2014) suggest, it may be that the firm's boundaries are determined not by the ability to transfer goods within the firm, but by the ability to transfer capabilities. Production fragmentation between two parts of the same corporation working in two industries with strong input-output links may signal the use of a common set of intangible inputs, knowledge, or expertise. These intangibles are a source of comparative advantage for the multinational firm, which entails specialisation in the production of input-output linked goods, even in the absence of physical shipments between within related parties.

Studying the nature of multinational supply chains, as well as the production fragmentation that they entail, is important because it can shed light on questions that go beyond the workings of the multinational firm. Global supply chains are informative about the fundamental nature of the firm itself – questions reaching back at least to Coase (1937) – and the make-versus-buy decision that lies at the centre of the outsourcing debate. In the same vein, Antras (2003) is a seminal contribution to the application of the theory of the firm’s boundaries to the structure of multinational firms.

Conclusions

Our finding that there is little international production chain fragmentation within the boundaries of the corporation raises a new set of questions to be explored in future research. Multinational corporation configurations are not always as simple as the Apple and Intel models. The ways that the multinational firm uses related parties and third-party suppliers are more complex than previously thought – for instance, to what extent do these third-party suppliers interact with different parts of the same corporation? Are multinational firms replicating their production chains abroad? The challenge in answering these questions is the availability of even more detailed data.

References

Alfaro, L and A Charlton (2009), “Intra-Industry Foreign Direct Investment,” American Economic Review, 99(5): 2096–2119.

Antras, P (2003), “Firms, Contracts, and Trade Structure”, The Quarterly Journal of Economics 118(4): 1375–1418.

Antras, P and E Helpman (2004), “Global Sourcing”, Journal of Political Economy 112(3): 552–580.

Atalay, E, A Hortacsu and C Syverson (2014), “Vertical Integration and Input Flows,” American Economic Review 104(4): 1120–48.

Bernard, A, B Jensen, J Bradford, and R Z Lawrence (1995), “Exporters, Jobs, and Wages in US Manufacturing: 1976–1987,” Brookings Papers on Economic Activity, Microeconomics: 67–119.

Coase, Robert H (1937), “The Nature of the Firm”, Economica 16(4): 386–405.

Consejeros Económicos y Financieros. SA (CEFSA) (2006), Informe Economico.

Helpman, E, M J Melitz, and S R Yeaple (2004), “Export versus FDI with Heterogeneous Firms”, American Economic Review 94(1): 300–316.

Johnson, R C, and G Noguera (2012), “Accounting for Intermediates: Production Sharing and Trade in Value Added”, Journal of International Economics 86(2): 224–236.

Ramondo, N, V Rappoport, and K J Ruhl (2015), “Intra-firm Trade and Vertical Fragmentation in US Multinational Corporations”, Journal of International Economics, forthcoming.