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while Ireland has some agglomeration in financial intermediation. That certainly
sounds like classic comparative advantage to me (Ireland is high human capital and
English speaking but has very few trees), not like the new economic geography. Under
the latter view, it would be just as likely that Irish affiliates were in wood products
and Latvian in financial intermediation. I think that this is really quite an important
point for policy. The new economic geography is very intellectually interesting and a
lot of fun, but differs dramatically in its policy implications from classic comparativeadvantage trade theory. Which view is correct determines whether or not an activist
policy can create agglomerations. Ireland successfully worked to attract computers
and pharmaceutical affiliates, but thank goodness no bright young economist tried to
go after ski resorts.
Now let me summarize my comments. The biggest contribution of the paper is
that it presents an empirical basis for choosing among positive theoretical models.
This is important because the right positive theory is a pre-condition for good policy.
Results in the paper: (1) favour horizontal models over vertical models; (2) favour
oligopoly models (with free entry) over small-group large-group monopolistic-competition
models; (3) lend support to the use of new heterogeneous-firm models; and (4) suggest
that affiliate/plant fixed costs increasing with distance. Finally, (5) there is evidence
that agglomeration may be an important empirical phenomenon, but its principal
cause is unclear.
I suppose that the worst thing I can say about the paper is that a number of its
findings confirm things found in other studies, and contradict nothing in the existing
literature that I can think of. But I do not view this as a weakness, especially for a policy
journal. Indeed, it is a strength in that it allows us to formulate policy with a good
deal more confidence than we might have had up to this point.
Karen-Helene Midelfart
Norwegian School of Economics and Business, Bergen, Norway
Motivated by the ongoing debate on globalization and multinationals, and whether
– and how – governments should aim at attracting multinationals, this paper sets out
to provide an analysis of German multinational firms that play a significant role in
the world economy. The authors argue that in order to answer the two questions –
‘Should governments target policies at multinationals?’ and ‘Which policies are likely
to be successful?’ – one needs to understand what the underlying forces are that are
driving foreign direct investment. Hence, the paper proceeds by providing an analysis
of the determinants and motives of foreign direct investment and foreign affiliate
activity of German firms. The authors employ a new and unique data set made
available by Deutsche Bundesbank, which allows for analyses that have so far only
been undertaken based on US and Swedish data.
Their point of departure is three different theoretical models of FDI: horizontal
FDI, vertical FDI and the knowledge capital model. They adopt the methodologies
developed by Brainard (1997), Markusen and Maskus (2002), Carr et al. (2001) and
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CLAUDIA BUCH ET AL.
Braconier et al. (2002) to analyse US and Swedish data, and apply these to the
German data. Hence, while their methodology is not new, they are the first to use
it analysing MNCs based in a major EU country. However, in addition to this, they
also provide interesting and novel descriptive statistics.
In their empirical analysis the authors include two different sets of explanatory
variables. The first is a set of economic variables that can typically not be directly
influenced by policy makers. They include country-, industry- and firm-specific
variables. The second set of variables is policy variables depicting foreign entry
restrictions, trade regime, and investment regime. Finally, the authors address the role
played by industrial agglomeration for the location of German FDI.
In short, their findings are as follows:
•
•
•
•
The horizontal model receives greater support from the data on German firms
than the vertical model and the knowledge capital model.
The heterogeneity of firms matters for internationalization patterns.
Proximity to other German multinationals’ affiliates matters for affiliate sales.
Policy measures are found to be of second order importance in determining the
location of FDI.
The study of Buch et al. provides interesting and novel insight about the determinants of German FDI. However, they include only a few policy variables in their
analysis. Moreover, policy variables that may possibly be of greater importance for
FDI among developed countries, such as tax regimes, are not included in the analysis.
See, for example, Braunerhjelm et al. (2000) for an analysis that includes such
variables. Failure to answer the policy questions is also due to the authors not
spending enough time trying to spell out what are the implications of their analysis
for policy.
A further comment relates to the method that the authors propose for distinguishing
between horizontal and vertical FDI. Using information on the NACE classification
of the parent company versus the affiliate they split MNEs into two categories:
•
•
If the parent firm and the foreign affiliate are in the same sector, this is assumed
to represent horizontal FDI.
If the parent firm and the foreign affiliate are in different sectors, this is assumed
to represent vertical FDI.
The idea to use industry classification as a tool to split between the two types of
FDI is nice, but the authors face a problem since firms and affiliates in their dataset
are classified according to a very crude classification, namely 24 NACE sectors. This
implies that a major part of vertical fragmentation of production takes place within
each of these sectors, and what appears as horizontal FDI may actually be vertical
FDI. On the other hand, even if parent firm and affiliate belong to different sectors,
this does not necessarily reflect vertical FDI. The fact that the dominating affiliate
sector is ‘wholesales trade’ underscores this point. In this case the affiliate is merely
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a type of sales office, and represents horizontal and not vertical FDI – regardless of
the sector of its parent firm.
Buch et al. aim at assessing how important agglomeration effects are for German
FDI. Unfortunately, there is a set of problems related to the way this analysis is set
up. First, the authors only assess the impact of proximity to other German affiliates
within the same industry, disregarding local firms within the same sector. Second, to
measure agglomeration effects they look at how FDI of German firms within the
same sector, and number of firms within the same sector, affect German affiliate sales.
But seeking the proximity to other German firms may imply two different things: it
may reflect that proximity to these firms as such is important due to positive externalities. However, it may also reflect the fact that all firms seek the same location, not
because of positive externalities, but because of the specific comparative advantage
of this given location. With their current set up the authors are therefore not able to
separate between agglomeration effects due to positive externalities, and comparative
advantage as determinants of location. Third, if one wants to assess the role played
by agglomeration effects, there are different ways of doing this. One alternative is to
look at how firms’ choice of location is influenced by proximity to other firms (see,
e.g., Braunerhjelm and Svensson). Another alternative is to look at how the profitability
of a firm is affected by proximity to other firms. The point of departure of the authors
is, however, to look at how sales (i.e. volumes) are affected by proximity to other firms.
And this lacks a proper theoretical basis.
The article by Buch et al. may provide new and important insight regarding the
behaviour of one of the major EU countries responsible for 10% of global capital flows
and 8% of FDI stocks internationally. But there is room for improvement regarding
methodologies as well as discussion of results and policy implications.
Panel discussion
Claudia Buch agreed with Jim Markusen that it is interesting to find strong similarities
between the main results of the paper based on German data and the results in the
literature on the US and Sweden. Related to the discussion of Jim Markusen,
Jaume Ventura pointed out that models of monopolistic competition can generate
output effects if the assumptions of a constant elasticity of substitution, free entry or
homogenous firms are relaxed. Claudia Buch replied to the discussants that it would
be very interesting to look more at entry at the sectoral level. She agreed that interactions between firm characteristics and distance seem to matter since the effect of
distance disappears in the regressions with firm fixed effects. With respect to the
measurement of the similarity index she mentioned that it is surprising to find a
positive and significant effect after controlling for sector and country fixed effects. She
argued that robustness checks show that the results on horizontal and vertical FDI