Host Country Financial Development and MNC Activity

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Chor, Davin; Foley, C. Fritz; Kalina, Manova; Stanley, Watt
Credit constraints; horizontal FDI; vertical FDI; export-platform FDI; heterogenous firms.; Not Applicable; Finance; International Economics
paper description
We present evidence that the level of ¯nancial development in FDI recipient countries system- atically a®ects the spatial distribution of multinational corporations' (MNCs) sales. Using detailed proprietary survey data collected by the Bureau of Economic Analysis (BEA) on US multinational activity abroad, we ¯nd that stronger ¯nancial development in the host country has a negative e®ect on the share of MNC a±liate sales that remain in the host country, indicating a reduced propensity towards horizontal FDI. Conversely, the share of a±liate sales that is re-exported to third-country destinations increases, suggesting an increased propensity towards export-platform FDI. We provide a three-country model with heterogenous ¯rms that rationalizes these observa- tions: More ¯nancially developed host countries foster entry by domestic ¯rms, making the local market more competitive for MNC products. This leads MNCs to orient their a±liates away from servicing the local market towards third-country markets instead.