Global COE Hi-Stat Discussion Paper Series 087

Research Unit for Statisticaland Empirical Analysis in Social Sciences (Hi-Stat)

Re-estimating the Knowledge-Capital Model:
Evidence from Japanese and U.S. Multinational Enterprises

Hi-Stat Discussion Paper

Kiyoyasu Tanaka

September 2009

Hi-Stat
Institute of Economic Research
Hitotsubashi University
2-1 Naka, Kunitatchi Tokyo, 186-8601 Japan
http://gcoe.ier.hit-u.ac.jp

Re-estimating the Knowledge-Capital Model:
Evidence from Japanese and US Multinational Enterprises
Kiyoyasu Tanaka*
Institute of Economic Research
Hitotsubashi University
Email: tanakak@ier.hit-u.ac.jp
September 2009
Abstract
This paper re-estimates the knowledge-capital model by James Markusen (2002) to study
market access and factor endowment explanations of foreign direct investment (FDI). I add tothe literature by combining consistent datasets on Japanese and U.S. multinational enterprises(MNE) in the period 1989-2002. To reduce potential bias, the prior specification of theknowledge-capital model is augmented with a number of additional control variables andestimated with a system GMM estimator. In the pooled sample, I find that both market accessand relative skill endowments matter for the pattern of foreign affiliate sales. When separately
estimating Japanese and US samples, the evidence shows that Japanese MNEs are encouraged
by relative unskilled-labor abundance in a host country, consistent with a vertical motive of FDI.
In contrast, U.S. MNEs concentrate on skill abundant countries, which is in favor of horizontal
FDI. These findings imply that combining datasets on multinational activities withheterogeneous motives of FDI is critical for finding evidence of the knowledge-capital model.
Keywords: Multinational firm, foreign direct investment, market access, factor endowment
JEL classification: F21, F23*

I would like to thank my advisors at the University of Hawai’i at Manoa: Professors Theresa

Greaney, Sang Hyop Lee, Seiji Naya, Ilan Noy, and Jack Suyderhoud. I am also grateful to
Toshiyuki Matsuura and Jota Ishikawa for helpful discussions and comments. All errors are my own.

1. Introduction
The rise of foreign direct investment (FDI) has been a prominent aspect of the
globalization over the recent decades. The average growth rate of world FDI flows exceeded over
20 % per year in the period 1986-2000 and outpaced the growth rates of world income andinternational trade. The global production by multinational enterprises (MNE) accounted for 10 %of world output in 2005, as measured by the value added of all foreign affiliates as a share ofworld GDP (UNCTAD, 2006).
The theory of multinational firms focuses primarily on market access and factor-cost
motives of FDI. Some MNEs are horizontally integrated by replicating the same production
process in multiple countries to economize on transportation and trading costs of international
trade (Markusen, 1984; Brainard, 1993; Markusen and Venables, 1998, 2000). Other MNEs arevertically integrated by geographically fragmenting stages of production to take advantage ofinternational factor-price differences (Helpman, 1984; Helpman and Krugman, 1985). Morerecently, the knowledge-capital model (KC model) developed by Markusen (1997, 2002)
encompasses both horizontal and vertical motives of FDI in a two-country general equilibrium.
The model allows for the simultaneous existence of vertical and horizontal MNEs by assuming
both trade costs and different factor intensities across production stages.
While the KC model integrates two separate motives of FDI in a coherent framework, a
recent body of empirical work provides mixed evidence for the vertical part of the KC model.
Consistent with a factor-cost motive, some studies find that MNE activity is positively influencedbyinternational differencesin relativeskill endowments

and larger in

relatively

unskilled-labor-rich countries (Carr, Markusen, and Maskus, 2001, hereafter CMM; Braconier,
Norbäck, and Urban, 2005, hereafter BNU). Yet, others find that MNE operations are greater inmore skill abundant countries (Brainard, 1997; Markusen and Maskus, 2001, 2002; Blonigen,
Davies, and Head, 2003, hereafter BDH;). These mixed results raise the questions of whether
MNEs pursue horizontal and/or vertical strategies in overseas production. What country1characteristics determine the pattern of affiliate activity? Does the KC model explain the rapid
expansion of multinationals?
This paper reconsiders market access and factor endowment explanations of FDI by
exploring three potential sources in the literature that may lead to the mixed support for the KC
model: MNE data, policy influences, and endogeneity problems. First, most studies are based on
US data of inward and outward affiliate sales (CMM, 2001; Markusen and Maskus, 2001, 2002;
BDH, 2003). This may lead to skewed results because the US is by far larger than any othereconomy and among the most skill abundant countries. On the other hand, affiliate data collectedfrom various national sources may have substantial variations in the survey qualities by sourceand year (BNU, 2005).1 To construct a consistent dataset with a variety of country pairs, I
combine new panel data on sales by foreign affiliates of Japanese MNEs with existing US MNE
data over the period 1989-2002. Systematic differences across the data sources are controlled byparent-country fixed effects. I also construct another measure of MNE activity by excluding
affiliate exports to the third country from total sales to mitigate a nuisance third-country effect inestimation.
Second, multinational activity has been influenced by recent policy changes characterized
by a shift from protectionism toward FDI to liberalization and promotion of MNE, but previous
studies focus on a limited number of explanatory variables. 2 An empirical specification is
augmented with a number of extra conditioning variables that may affect multinationals: acommon language, a land border, landlocked countries, island nations, regional trade agreements,
bilateral investment treaties, bilateral tax treaties, tax sparing agreements, euro currency, andfinancial crises. Third, I employ the system generalized-method-of-moments (GMM) estimator
developed by Blundell and Bond (1998) to address previously unexplored endogeneity issues.
1

See Lipsey (2003) for a survey on the concept, measurement, and data of FDI.
The number of international investment agreements such as bilateral investment and double
taxation treaties reached almost 5500 at the end of 2005, which consisted of 2495 bilateral investment
treaties, 2758 double taxation treaties, and 232 other agreements that contain investment provisions(UNCTAD, 2006).
2

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The GMM estimation also extends previous findings on the KC model by investigating whether
an exogenous component of key variables affects multinational activity.
Robust to a wide variety of alternative specifications, I find little evidence that affiliate
sales are higher in relatively unskilled-labor-rich countries in a pooled Japanese and US sample.
The vertical part of the KC model is not supported by the pooled data. However, I find in separate
JapaneseandUSsamplesthatJapaneseaffiliate

sales

are

largerin

relatively

unskilled-labor-abundant countries but US affiliate sales are smaller in such countries. Thisfinding helps in explaining weak support for vertical MNE in previous literature that uses almost
exclusively the US data.
I confirm that market access plays a key role in determining a pattern of affiliate sales.
The benchmark results suggest that (1) a 1 billion dollar increase in total GDP levels of home andhost countries expands affiliate sales by 20 million dollars, (2) a 1 billion dollar increase in GDP
differences between these countries reduces affiliate sales by 11 million dollars, and (3) aone-percentage-point increase in trade barriers as measured by a survey index of protectionism
raises affiliate sales by 90 million dollars. These findings lend considerable support for thehorizontal part of the KC model.
Section 2 overviews the theory and evidence on the KC model. Section 3 discusses threemain improvements in empirical strategies: a largely augmented specification, new panel data on
Japanese MNE with data sources on independent variables, and a brief description of a system
GMM estimator. Section 4 contains the results. Section 5 concludes.

2. Theory and Evidence on the Knowledge Capital Model
The KC model developed by Markusen (1997, 2002) is a two-country generalequilibrium model that allows for both horizontal and vertical MNEs. The model assumes two
homogeneous goods (X and Y), two countries (home and foreign), and two homogeneous input
factors, unskilled and skilled labor. Good Y is unskilled-labor-intensive and produced under3

constant returns to scale in a competitive industry. Good X is skilled-labor-intensive andproduced under increasing returns to scale, and producers are subject to Cournot competition withfree entry and exit. Firms in this sector have headquarters services (blueprints, management,
R&D, etc.) and production facilities. Trade costs exist for international trade and markets aresegmented. In this structure, three types of firms may emerge; (1) horizontal MNE headquarteredin the home country maintain production facilities in both countries, (2) vertical MNE
headquartered in the parent nation have a single plant in the foreign country, which may export tohome, and (3) national firms have headquarters services and a single plant in the home country,
which may export to the foreign country.
Knowledge capital plays a key role in the existence of multinational firms. First, aparent firm can simultaneously supply headquarters services to both domestic and foreign plants
at low cost due to a joint-input property of knowledge capital. The additional cost of building asecond plant is small relative to the cost of establishing a new firm with a headquarters and plantabroad. Multi-plant economies of scale generate a cost advantage for horizontal MNE. Second,
headquarters services are more skilled-labor intensive than production activities and can begeographically fragmented from production facilities. Different factor intensities and separabilityof knowledge capital generate a cost advantage for vertical MNE.
Based on numerical simulations, the KC model generates key predictions on theaggregate pattern of MNE activity as a function of characteristics of both parent and hostcountries. First, the theory predicts that affiliate production should be larger in the presence ofgreater factor-price differentials across countries, which are partly driven by differences inrelative skill endowments. More specifically, when a host country is skill abundant relative to aparent nation, there is little incentive for firms to establish foreign plants because unskilledworkers for production are too costly abroad. As the host country becomes moderately
unskilled-labor abundant, a decline in the relative cost of skilled workers at home and unskilledworkers in the foreign country encourages headquarters activity and foreign production of4horizontal MNE. A further decline in host-country skill abundance creates larger unequal factor
prices across countries, which in turn promote vertical MNE to exploit much cheaper unskilledlabor abroad. Thus, MNE activity should be larger in less skill abundant countries relative toparent nations and vice versa.
Second, a factor-price motive combines with the market size effects to further expand
affiliate production because multinationals have an incentive to concentrate production in a large
market for plant-level economies of scale. Particularly, larger market size allows vertical firms tosell the greater proportion of final output in a local market and reduce trade costs to importproducts back to home. MNE activity should be more pronounced in skilled-labor-scarcecountries that have larger markets relative to parent nations.
Third, the total market size of home and host countries positively affects affiliate activity.
When the total market size is larger, national firms with high marginal costs in serving foreign
markets are replaced by horizontal MNEs with high fixed costs. Fourth, differences in the market
size discourage production by multinationals. When market sizes are largely different, horizontal
MNEs with high fixed costs are replaced by national firms that prefer the large country as a siteof production to avoid costly production capacity in the small market.
Previous work focuses primarily on these implications of the KC model and evaluates therelative importance of a factor-cost motive by exploring the effects of relative skill endowments
on MNE activity. The study by CMM (2001) estimates a specification that includes skill
differences defined as the ratio of skilled labor to total labor force in a home country minus that ina host country and an interaction term between skill differences and market-size differences.
Using panel data on US inbound and outbound affiliate sales in 1986-1994, they find that affiliate
sales are positively correlated with the skill differences and its positive impact is more
pronounced in relatively large host markets. An additional support for the vertical motive isprovided by BNU (2005), who specify skill differences as the relative unskilled-labor abundance
in a host country compared to a home nation and use data on affiliate sales with expanded country

5

coverage. However, data on affiliate sales developed from a diverse set of national sources may
not be internationally comparable.
In contrast, when skill differences in the CMM’s specification are defined as theabsolute value to avoid a sign reversal in the difference term, larger skill differences reduce
affiliate sales in the CMM’s data (BDH, 2003).3 The evidence in favor of the horizontal, rather
than vertical, part of the KC model is further added by Markusen and Maskus (2001), who findthat the levels of US outward affiliate sales disaggregated by destination markets are greater inmore skill abundant countries. Markusen and Maskus (2002) show that the horizontal and KC
model performs well in explaining a pattern of aggregate MNE activity, but the vertical model isa poor characterization of such activity.
However, these studies are almost exclusively based on US data of multinational
activity in which the US involves either a parent country or a host country in every observation.
In addition, most work does not fully address a variety of other important determinants of FDI
and pay little attention to endogeneity of key regressors. These weaknesses may lead to biased
estimates for key regressors. In sum, all of these concerns leave open the question of whether
relative skill endowments affect multinational activity.

3. Empirical Strategy
3.1. Specification
Previous studies on the KC model have focused on a relatively small number of
explanatory variables and omitted other important determinants of FDI. In order to reduceomitted variables bias, I largely augment a specification for a parent and host country i and j attime t:3

Carr et al. (2003) criticize the absolute value specification suggested by BDH because it
imposes symmetry restrictions on affiliate sales between countries. They suggest that separating
samples either for inbound and outbound US affiliate sales or for positive and negative skill
differences is a more reasonable way to overcome the sign reversal issue.

6

RSALEijt = β0 +β1SKILLijt + β2SKLGDPDFijt + β3GDPSUMijt + β4GDPDIFSQijt+ β5TCjt + β6ICjt + β7DISTij + β8CMLij + β9BORDij + β10LANDLj+ β11ISLANDj +β12RTAjt +β13BITijt +β14BTTijt +β15TSPijt+β16EUROjt +β17CRISjt +β18JPMNE + ΣtγtTt + ηij+ εijt
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(1)

RSALE is the real volume of sales by affiliates of i in j at time t.
SKILL is the relative skilled-labor abundance in i compared to j at t.
SKLGDPDF is an interaction term between SKILL and the difference in real GDP levels
between i and j at t.
GDPSUM is the sum of real GDP levels of i and j at t.
GDPDIFSQ is the square of differences in real GDP levels in i minus that in j at t.
TC is trade costs for foreign products imported to j at t.
IC is investment costs for multinational operations in j at t.
DIST is the distance in kilometers between the capital cities in i and j.
CML is a binary variable equal to one if i and j have a common language.
BORD is a binary variable equal to one if i and j share a national border.
ISLAND is a binary variable equal to one if j is an island nation.
LANDL is a binary variable equal to one if j is a landlocked nation.
RTA is a binary variable equal to one after j joins a regional trade agreement at t.
BIT is a binary variable equal to one after a bilateral investment treaty between i and j enters
into force at t.
BTT is a binary variable equal to one after a bilateral tax treaty between i and j becomes
effective at t.
TSP is a binary variable equal to one after a tax sparing agreement between i and j enters into
force at t.
EURO is a binary variable equal to one after j introduces the euro at t.
CRIS is a binary variable equal to one if j has a financial crisis in t-1.
JPMNE is a binary variable equal to one if i is Japan.
Tt is a set of time fixed effects, with γt a vector of the coefficients.
ηij is a country-pair fixed effect.
εijt is an error term, which is assumed to be N(0, σ2).
This paper addresses the main hypothesis that MNE activity motivated partly by factor

price differentials should be larger in more unskilled-labor-rich host countries relative to homenations. This key prediction is captured by the SKILL variable. Following BNU (2005), thevariable is defined as follows:

SKILL SK Home
USK Home  USK Host
SK Home  SK Host
USK Home7(2)

where SK Home and SK Host are skilled labor in home and host countries, and USK Home and
USK Host are unskilled labor in home and host nations.4 A rise in SKILL implies an increase inskilled-labor abundance of the home country relative to the host country or a rise inunskilled-labor abundance of the host country relative to the parent country. An expected sign of
SKILL is positive.
An interaction term between SKILL and GDP differences captures the theoreticalprediction that a positive influence of skill endowments on MNE activity should be more
pronounced in larger countries. Since a rise in the relative size of host markets corresponds to a
decline in GDP differences between home and host countries, an expected sign of SKLGDPDF is
negative. These first two terms are key regressors to identify a vertical motive of Japanese and US
MNEs.
Horizontal motives of MNE activity are captured primarily by GDPSUM, GDPDIFSQ,
and TC. As explained in the previous section, the KC model predicts that GDPSUM and
GDPDIFSQ should have positive and negative coefficients, respectively. Higher inward trade
costs in the host country promote horizontal MNE that invest abroad for the savings of trade costs.
An expected sign of TC is positive. Investment barriers deter MNE entry into host markets, andIC should have a negative coefficient. Distance between countries is a proxy not only fortransport costs between countries but for information and monitoring costs on business operationsin the foreign country. An expected sign of DIST is unclear.
As is common in the gravity model of international trade (Rose, 2004), I include
time-constant country characteristics such as a common language (CML), a land border (BORD),

4

It is controversial whether the effects of skill endowments should be captured bydifferences in relative skill endowments across countries or by the absolute value of skill differences(Carr et al., 2003; BDH, 2003). SKILL is used to avoid the problem that a rise in skill differences
implies a divergence in relative skill endowments when a parent nation is more skill abundant but aconvergence when a parent country is less skill abundant.

8and island (ISLAND) and landlocked status (LANDL).5 Since CML reduces business transaction
costs in foreign countries for multinationals, it should have a positive coefficient. BORD
facilitates production networks by linking parent and affiliate firms through land transportations,and an expected sign of BORD is positive. On the other hand, island nations lack the means ofland transportation to nearby markets and incur higher transportation costs to regional markets. A
predicted sign of ISLAND is negative. Lastly, landlocked nations are disadvantageous to marinetransportation for a lack of ocean ports. An expected impact of LANDL is negative.
A rich body of empirical work investigates the effects of international investment
agreements on multinationals. My study is distinctive in that MNE activity are measured more
directly by affiliate sales than FDI flows and stocks used in most studies. Regional trade
agreements (RTA) consist of trade liberalization within the region and investment liberalization
toward foreign investors (Blomstrӧm and Kokko, 1997). Falling internal trade costs and the larger
size of regional markets may expand affiliate exports to integrated countries. The investment
liberalization contains the elimination of discriminatory policies against foreign firms as well as
dispute resolution mechanisms, which may reduce investment barriers to FDI. An expected signof RTA is positive.
The common objective of bilateral investment treaties (BIT) is to protect the property
rights of foreign investors by improving the standard of legal protection, assuring compensation
for the expropriation by host governments, and establishing dispute settlement mechanisms(Egger and Pfaffermayr, 2004; Hallward-Driemeier, 2003). BIT should have a positive effect onaffiliate sales.6 On the other hand, bilateral tax treaties (BTT) have ambiguous influences on
MNE activity (Blonigen and Davies, 2004). BTT play a role in reducing double taxation on profits
arising from business operations in a foreign country and eliminating tax avoidance of5

For US MNE, a common language includes English-speaking countries and a land bordercontains Canada and Mexico.
6
Japan and the US have signed BIT with 10 and 45 host countries by the year 2002,
respectively. The vast majority of these signatories represent the developing countries.

9multinationals that are able to shift taxable profits from high to low tax countries. While a
reduction of tax distortions may promote MNE activity in host signatories, tax treaties also
weakens an incentive of MNE to invest abroad for tax minimization reasons.
Tax sparing agreements (TSP) are designed to resolve tax issues faced primarily by thedeveloping countries that attempt to attract foreign investment through fiscal incentives such as
tax exemptions (Hines, 2001; Azémar et al., 2006). A major issue is that the fiscal incentives do
not necessarily reduce a tax burden of multinationals who claim a foreign tax credit in their homecountry. For instance, Japan has the worldwide tax system that provides a foreign tax credit toJapanese firms for the taxes already paid in foreign countries in order to avoid double taxation.7
Under a tax credit rule, the tax savings from fiscal benefits by host governments merely decrease
the amount of the foreign tax credit that multinational firms can claim, making their after-tax
profits unchanged. To avoid this, TSP allow firms to claim a foreign tax credit for additional
income that have been spared by fiscal grants in foreign countries. A predicted sign of TSP is
positive.
Monetary economic events affect MNE activity. The common currency such as the euro(EURO) decreases transaction costs within the member countries and stimulates trade flows in theregion (Rose, 2004). While falling internal trade costs expand affiliate exports to regional markets,
they may stimulate multinationals to concentrate their production in lower cost countries within
the monetary union.8 An expected sign of EURO is ambiguous. On the other hand, the financial
crises (CRIS) affect MNE operations through two channels as argued by Lipsey (2001); thestagnation in a host market might decrease local sales of foreign affiliates and the devaluation of a
local currency could raise their export sales. The expected sign of CRIS is unclear. The predicted
signs for the independent variables are summarized as follows:
7

Japan signed the first tax sparing agreement with Pakistan in 1959 and maintained tax
sparing provisions in force with 13 countries at the end of 2000, with most of these countries
concentrated in Asia. In contrast, the US does not grant tax sparing provisions.
8
Aristotelous (2005) examines the effects of euro currency on US FDI flows into theEuropean Monetary Union members.

10[Table 1 around here]

3.2. Data
Empirical work on multinationals has always faced a trade-off between data consistency
and country coverage. The more data are collected from a variety of national sources, the lessconsistent the data are due to deviations in measurement of foreign affiliate activity and thevarying qualities across and within sources. For example, a survey on overseas business activities
of Japanese parent firms is annually collected by the Ministry of Economy, Trade, and Industry(METI). Since responding to the METI survey is not mandatory for parent firms, the official dataon Japanese MNE are known to suffer from low response rates of around 60 %, varying samplesof parent firms over time, and widely fluctuating sales at the affiliate level (Lipsey, 2003).
To improve the Japanese survey data, Matsuura (2004) constructs panel data at theaffiliate level and estimates missing sales for certain affiliates in the years 1989-2002.9 Affiliate
sales in the improved data are aggregated over manufacturing sectors to the country level. To
expand country coverage, I also exploit data on foreign affiliates of US parent firms in nonbank
manufacturing from the U.S. Bureau of Economics Analysis (BEA). Affiliate sales of Japaneseand US MNEs are measured in millions of year 2000 US dollars using the average of Yen-dollar
annual exchange rates in the 1989-2002 period and a US wholesale price index from theInternational Financial Statistics of the International Monetary Fund.
To check for consistency between the RIETI and BEA datasets, aggregate sales byJapanese manufacturing affiliates in the US from the RIETI source are compared with those fromthe Foreign Direct Investment in the United States published by the BEA. I find that Japaneseaffiliate sales from the RIETI are overestimated by 71.9 % on average for 1989-2002, compared9

The RIETI data are available at http://www.rieti.go.jp/jp/database/d08.html. See Matsuura(2004) for details.

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to the BEA source.10 Since such a discrepancy between Japanese and US affiliate sales would behigher (lower) in the larger (smaller) country. I control for the systematic differences in the databy a dummy variable for Japanese MNE.
I construct an alternative measure of MNE activity that excludes affiliate exports to athird country from total sales because the KC model is formulated in a two-country setting. The
RIETI reports local sales and exports to a home country as a share of Japanese affiliate total sales.
The sum of these sales is aggregated across manufacturing industries to the country level. I
exploit the BEA data on local sales and export to home by the US majority-owned foreign
affiliates (MOFA).11 The sum of sales to local and home markets is measured in millions of US
dollar analogously as affiliate total sales. Summary statistics and a list of countries included inregressions are shown in the appendix.
Standard data sources are used for the independent variables. Data on skill endowments
are taken from the Yearbook of Labor Statistics published by the International Labor Organization(ILO). Skilled labor in each country is defined as the sum of workers classified as occupational
categories 0/1 (professional, technical, and related workers) and categories 2 (administrative
workers). Unskilled labor is defined as the total labor minus the skilled labor.12 Data on real GDP
measured in billions of year 2000 US dollars are taken from the World Development Indicators.13
Trade costs are measured by an index of national protectionism on imports from theWorld Competitiveness Report jointly published by the International Institute of Management
Development (IMD) and the World Economic Forum for 1989-1995 and the World
Competitiveness Yearbook by the IMD for 1996-2002. The index is developed from an extensive
business survey that measures the perceptions of multinational managers on the business

10

The deviations across the data sources may be due to survey methods, the survey quality,
and the definition of foreign subsidiaries.
11
MOFA are the foreign business enterprise in which the combined ownership of all US
parents exceeds 50 %.
12
Data appendix for details in constructing the skill variable is available upon request.
13
Taiwan GDP data are taken from the Department of Commerce, Taiwan.

12environment across countries. Trade cost is defined to range from zero to 100, with a higher
number indicating greater trade barriers. Investment cost is a simple average of several survey
indices from the same source. Investment cost is defined to range from zero to 100, with a higher
value indicating larger investment barriers. Investment impediments include foreign investment
restrictions, limitations on negotiating joint ventures, restrictions on hiring and firing practices, alack of the fair administration of justice, limited accessibility of local and foreign capital markets,
inadequate protection of intellectual property rights.
Data on distance measured in kilometers between capital cities of home and hostcountries are from the International Trade Data website of Raymond Robertson (formerly
maintained by Jon Haveman). Data on a common language are from the same website. I use theCIA’s World Factbook for a land border, island and landlocked nations. I exploit data from theWorld Trade Organization to construct an indicator for 4 regional trade agreements: EU, NAFTA,ASEAN Free Trade Area (AFTA), and Mercosur.14 Information on bilateral investment treaties
is taken from the Bilateral Investment Treaties 1959-1999 published by the United Nations.15
Whether BIT enters into force after signature is checked by the official websites of Japan and theUS.
Data on bilateral tax treaties for Japan and the US are taken from the International Bureauof Fiscal Documentation and Blonigen and Davies (2004), respectively. Data from Azémar et al.
(2006) and OECD (1998) are used to create an indicator of tax sparing agreements for Japan.

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The European Union (EU) was formed when the Maastricht Treaty was signed in February
1992 and entered into force in November 1993. The North America Free Trade Area (NAFTA) isdefined to encompass the Canada-US Free Trade Agreement (CUFSTA) that came into effect inJanuary 1989. The ASEAN Free Trade Area (AFTA) was signed in January 1992 and came into force
in January 1993. The Common Market of the South (Mercosur) began when the Treaty of Asunción
was signed in March 1991.
15
Available at http://www.unctad.org/en/docs/poiteiiad2.en.pdf. It presents bilateral country
names, date of signature, and date of entry into force during the period 1959-1999.

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Eleven members of the EU introduced the euro as a common currency in 1999 and Greece
adopted the euro in 2001.16 Financial crises include Mexico in 1994 and East Asia in 1997.

3.3. Estimation Issues
A concern in estimating a vertical motive of MNE is potential endogeneity of thedependent variable and host-country skill endowments.17 Multinationals play a growing role in
the global production, and affiliate activity may affect the skill composition of overseas
employment. Such a concern is particularly relevant for skill-scarce countries in which vertical
MNEs primarily arise to exploit factor cost differentials. Multinationals may hire highly skilledlabor in the skill-scarce country possibly because such workers have high labor productivity per
output. It is likely that MNE activity may shift host-country skill abundance upward and reduce
the SKILL variable. Such an endogeneity problem would bias the coefficient of SKILL downward
and make it difficult to identify the vertical motive of MNE in non-experimental data.
The GMM estimator developed by Arellano and Bond (1991), Arellano and Bover (1995),
and Blundell and Bond (1998) offer an alternative solution to correct for endogeneity problems inpanel data. To illustrate, I start by taking the first difference of equation (1) to eliminate
country-pair fixed effects. Under the assumption that the error term in equation (1) has no serial
correlation (I test this assumption), I create an instrument matrix of two to four period lagged
levels of endogenous variables (skill endowments, GDP levels, and trade and investment costs)
and lagged levels of exogenous variables (all other regressors). The GMM estimator then exploits
a set of moment conditions that consist of the instrument matrix and the matrix of differenced
error terms.

16

Among these countries, my sample includes Austria, Belgium, Finland, Germany, Ireland,
Italy, Netherlands, Portugal, Spain, and Greece.
17
I also take into account endogeneity of GDP levels, and perceived trade and investment
costs in GMM estimation.

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To improve efficiency, Blundell and Bond (1998) develop a system GMM estimator byfurther assuming that changes in any instrumenting variables are uncorrelated with thecountry-pair fixed effects. Using equation (1), the system GMM estimator creates an additional
instrument matrix of lagged changes of endogenous variables and current changes of exogenous
variables. The new instrument matrix and the matrix of the composite error terms of country-pair
fixed effects and idiosyncratic errors then provide an addition set of moment conditions that canbe exploited to obtain consistent and efficient estimates of the coefficients.
I report a two-step estimator that is asymptotically efficient and robust to
heteroskedasticity and arbitrary patterns of autocorrelation within country pairs. Since theparameters’ standard errors in the two-step estimator are known to be severely downward biased
in a finite sample, a small-sample correction for the two-step standard errors developed byWindmeijer (2005) is employed. In addition, I conduct specification tests to check the validity of
instruments used: the Hansen test of overidentifying restrictions (Hansen, 1982) and
Arellano-Bond test for autocorrelation. These statistics test the joint validity of the moment
conditions and second-order autocorrelation of differenced errors, respectively.

4. Estimation Results
4.1. Benchmark Results
The benchmark results for equation (1) are presented in Table 2. Column (1) excludes
additional controls and column (2) adds in a large number of such controls, with affiliate total
sales as a dependent variable. Column (3) replaces total sales with sales to local and homemarkets in order to mitigate third-country influences. Since the presence of heteroskedastic errors
is detected in initial regressions by a Breusch-Pagan test, these specifications are estimated by aweighted-least-squares (WLS) estimator with the squared sum of GDP levels as the weight.
Robust standard errors are reported. Column (4) employs a system GMM estimator for affiliate

15

total sales to resolve potential endogeneity of skill endowments, GDP levels, and trade andinvestment costs.
There are several notable results in Table 2. First, the coefficient of SKILL is notstatistically different from zero across specifications.18 Aggregate Japanese and US affiliate sales
are not positively associated with relative unskilled-labor abundance in a host country compared
to a parent nation. This contrasts sharply with previous work on the KC model; differences inrelative skill endowments between countries have a significantly positive impact on sales by US
outward and inward affiliates (CMM, 2001), the skill differences have a significantly negative
effects on US outward affiliate sales (BDH, 2003), and the SKILL variable in BNU (2005) has asignificantly positive coefficient in an enlarged dataset on affiliate sales.
[Table 2 around here]
A major difference in my paper from previous work is that new panel data on Japanese
MNEs are combined with US data. As shown later, since US multinationals concentrate primarilyon skill abundant countries, US affiliate sales tend to be discouraged by the relative
unskilled-labor abundance in a host market compared to the US. On the other hand, since
Japanese multinationals have relatively large sales in less skilled-labor abundant nations,Japanese affiliate sales tend to be encouraged by the relative unskilled-labor abundance in a hostcountry compared to Japan. Pooling Japanese and US samples may cancel these opposite effects
out, possibly leading to the insignificant coefficient estimates.
The interaction term of SKILL and GDP differences does not enter with significanceacross specifications except for column (3). Although the interaction is intended to capture theprediction that vertical MNE activity should be more pronounced in relatively large host markets,
my sample does not cover relatively skilled-labor-scarce countries that are larger than Japan and18

I find mixed evidence for a vertical motive in the regressions that replace SKILL with theskill difference term that is created from the ILO data and from the Barro-Lee’s data on educational
attainment of people over age 25. These results are available upon request.

16

the US. It may be difficult to find an interactive effect of skill endowments and relative market
sizes in my data.
Consistent with previous literature, the total market size has significantly positivecoefficients. Column (2) imply that a 1 billion dollar increase in bilateral GDP levels raises
affiliate total sales by 20 million dollars. Since much of variations in GDP sum are due tohost-country GDP levels, I also calculate a marginal effect of the host market size on affiliate
sales, evaluated at the mean of SKILL and GDP difference.19 The implied marginal effectsuggests that a 1 billion dollar increase in the host market size raises affiliate total sales by 30
million dollars. Thus, the results confirm the previous findings that multinational sales arestrongly encouraged by the market size.
The square of GDP differences has a significantly negative impact on affiliate sales.
Column (2) suggests that affiliate sales increase by 11 million dollars as GDP differences
decrease by 1 billion dollars, when a marginal effect is evaluated at the mean of SKILL and GDP
differences.20 Consistent with the finding in CMM (2001), a convergence in the bilateral market
size increases affiliate sales, holding the total market size constant. The KC model implies thathorizontal MNEs with high fixed costs replace national firms with lower marginal costs inserving countries of similar size.
Host-country trade costs have significantly positive coefficients in columns (2) and (3).
The Second column suggests that a one-percentage-point increase in the trade cost index raises
total affiliate sales by 90 million dollars. The results support horizontal motives of FDI toeconomize on costs of international trade by local production. In sum, the benchmark results
produce an expected sign pattern for the market-access variables with sensible magnitudes andlend considerable support for horizontal, rather than vertical, motives of multinational activity.

19∂Rsale / ∂GDP Host = 19.5 + 0.0008*2*GDP Difference + 1.25*Skill = 30.2 at the meanvalues of the independent variables.
20∂Rsale / ∂GDP Difference =－0.0008*2*GDP Difference－1.25*Skill =－10.7 at themean values of the independent variables.

17

Several additional findings are evident. Many of extra control variables enter withsignificance in regressions and an F-test statistic rejects the null of zero slopes at the one percent
significance level. Omitting these important variables may lead to insignificant coefficients oftrade costs in column (1). The results in column (3) for affiliate sales excluding exports to a third
country are reasonably similar to those in column (2) for total sales, even when the same hostcountries are used in unreported regressions. This suggests that country determinants ofmultinational activity approximated by a bilateral relationship are relatively robust to
third-country influences.
In column (4), the validity of instruments for suspected endogenous regressors is
supported by moderate p-values of a Hansen test and a serial correlation test. Although thecoefficient of SKILL is insignificant in GMM estimation, the larger GMM estimate implies that
endogeneity problems may bias the WLS estimates of SKILL downward. In contrast, I find that asignificantly positive coefficient of the GDP-sum variable is robust to potential endogenous bias.
This confirms a positive market effect on affiliate sales.

5.2. Log Specification
The benchmark results support the horizontal part of the KC model by showing astrongly positive effect of market size on affiliate sales. Since an estimating equation is fairly
similar to early work, the results illustrate the importance of Japanese MNE data, extra control
variables, and a system GMM estimator. However, the regression results may be driven by highly
skewed data on affiliate sales in which some observations have extremely large values. I explore
the robustness of the results by specifying equation (1) in a log-linear form to improve the skewed
data. Note that an interaction term of SKILL and GDP differences must be dropped for perfectcollinearity. For multicollinearity issues, I use host-country GDP levels in place of GDP sum andthe square of GDP differences.

18Columns (1)-(4) of Table 3 present the results in a log specification for thecorresponding columns of Table 2. A notable finding is that the coefficients of SKILL aresignificantly positive in column (1) but a significantly negative in column (2) that includes extra
control variables. This suggests that the positive coefficient of SKILL in column (1) may pick up
positive influences subsumed in the error term and would suffer from omitted variables bias. Sucha concern is more pronounced by the fact that many of time-varying dummy variables such as
regional trade agreements enter with significance in column (2). Since SKILL has insignificant
coefficients in columns (3) and (4), the results show little evidence for a vertical motive of MNE
activity.
[Table 3 around here]
The pattern of sign and statistical significance for the other main and control variables isgenerally consistent with those in the benchmark results. Affiliate sales are larger in larger hostmarkets with higher inward trade barriers while they are smaller in higher investment-cost
countries that are more distant from a parent country. Adjusted R-squares in a log specification
have declined compared to those in the corresponding specification in Table 2, suggesting that
equation (1) is a preferred specification. Overall, my sensitivity analysis confirms the benchmark
results that support market access, rather than factor-cost, motives of FDI.

5.3. Japanese versus US MNEs
All of my regressions to this point have assumed identical effects of country
determinants across Japanese and US MNEs that may mask heterogeneity across these
multinational behaviors. I examine this by estimating a log specification separately for Japaneseand US samples with common host countries.21 Regional trade agreements are decomposed into
NAFTA, EU, AFTA, and Mercosur to relax the assumption that they have the same effect on

21

The Japanese sample includes the US, and the US sample contains Japan. The exclusion ofthese countries from the data does not change the results in a noteworthy way.

19

MNE activity. Note that a land-border dummy is omitted in the US regressions for
multicollinearity with the NAFTA dummy.
Columns (1) and (2) of Table 4 report the WLS estimation for Japanese and US samples
by using a log of host-country GDP as the weight to alleviate scale effects of market size.
Columns (3) and (4) show the fixed-effects (FE) estimation for the corresponding samples todistinguish the time-series contributions to the WLS results.22 The WLS estimates for SKILL aresignificantly positive for Japanese MNEs but significantly negative for US MNEs, suggesting thatJapanese affiliate sales are larger in less skill-abundant countries but US affiliate sales are larger
in more skill-abundant countries.23 That Japanese MNEs may have stronger vertical motives thando US MNEs is also supported by the FE results that SKILL has a significantly positivecoefficient only for the Japanese sample. The elasticity of Japanese affiliate sales with respect to
SKILL lies between 1.1 and 3.3 while it is between -1.2 and 1.1 for US affiliate sales.
[Table 4 around here]
The finding that US MNEs are attracted to skill abundant countries is consistent withprevious work such as Markusen and Maskus (2001, 2002), and BDH (2003). My analysis showsthat Japanese MNEs primarily seek less-skilled labor overseas and may have stronger verticalmotives than do US MNEs. This confirms the finding in Eaton and Tamura (1994) that
host-country education has stronger effects on US outward FDI stock than Japanese outward FDI.
My study is distinctive in that Japanese MNE activity measured by affiliate sales is lower in skill
abundant countries.
The coefficient of market size is larger for Japanese MNEs than it is for US MNEs in
the WLS estimation, and vice versa in the FE estimation. This implies that Japanese MNEs are
22

Since the number of country pairs relative to periods is small in separate Japanese and US
data, a system GMM estimator is not employed for a concern about a small samples bias. Endogeneity
is a less serious concern in comparing the coefficients of key regressors across Japanese and US
MNEs if the coefficients are biased in the same manner.
23
The results are robust to the specifications in which alternative measures of SKILL areconsidered, including a ratio of skilled labor to the total labor and Barro-Lee’s educational attainment
levels in a host country. These results are available upon request.

20

more likely to consolidate offshore production in a large country, and US MNEs tend to respond
more strongly to the growth of local markets. The KC model predicts that country size should be
more important for vertical MNEs than it is for horizontal MNEs because vertical firms incurlarger transport costs in smaller markets by shipping back the greater proportion of final output totheir home country. In the short run, the host market growth is more important for local sales
associated with horizontal MNEs than export sales by vertical MNEs. Thus, the results bolster theidea that Japanese MNEs may have stronger vertical motives than do US MNEs.
Host-country trade and investment costs discourage Japanese affiliate sales morestrongly than US affiliate sales. Trade barriers generally encourage horizontal MNEs but deter
vertical MNEs that may transport intermediate goods to their foreign affiliates for further
processing. Investment impediments are more deterrent to vertical than horizontal FDI, as Yeaple(2003) finds that business barriers are more detrimental to export sales than local sales for US
outward affiliate sales. Thus, the results on trade and investment costs also imply that verticalmotives may be stronger for Japanese than US MNEs.
Turning to time-constant country characteristics, affiliate sales are discouraged by thegreater distance between countries but promoted by a common language and island nations.24
Landlocked nations do not affect affiliate sales. Time-varying country characteristics display thevarying impact on affiliate sales across specifications, and I focus on the FE estimates that areless biased in estimating dynamic effects. Japanese MNE activity grew within countries with
regional trade agreements more rapidly than did US MNE activity. For example, Japaneseaffiliate sales increased in the ASEAN free trade area by (exp(0.48) – 1≈) 61.6 %, compared to(exp(0.19) – 1≈) 20.9 % for US affiliate sales.25
Bilateral investment agreements increased US affiliate sales but had no effect on
Japanese affiliate sales. Bilateral tax treaties decreased Japanese affiliate sales but raised US
24

Island nations in the regressions include Australia, New Zealand, Philippines, andSingapore, which may explain a larger coefficient for Japanese MNEs.
25
AFTA in the regressions contains Malaysia, Philippines, Singapore, and Thailand.

21

affiliate sales. Tax sparing agreements with Japan entered into force for Turkey in 1994 andMexico in 1996, and Japanese affiliate sales were 0.8 times larger in these countries after tax
sparing provisions were in place.26 This estimated effect is small relative to the elasticity found in
Hines (2001) that lies between 1.4 and 2.4 for cross-sectional data on Japanese outward FDI
stocks. Lastly, the euro currency is negatively correlated with US affiliate sales while financial
crises show no significant effect on MNE activity.

5. Conclusion
This paper reconsiders market access and factor endowment explanations of MNE
activity by estimating the knowledge capital model of Markusen (2002) for a new panel dataset
on Japanese and US MNEs in the period 1989-2002. Similar to previous weak support for a
vertical motive of FDI, my empirical results provide little evidence that relative skill endowments
affect affiliate sales in a pooled Japanese and US sample. But the results confirm that market
access plays a key role in MNE activity. This conclusion is robust to a variety of alternative
specifications such as the inclusion of a number of control variables, the alternative dependent
variable of affiliate total sales, and the use of a system GMM estimator. It is also robust to a log
specification of an estimating equation.
However, econometric analysis for separate Japanese and US samples present strikingly
contrasting results for the pattern of Japanese and US affiliate sales. My estimates suggest that a
1 % increase in host-country unskilled-labor abundance relative to a home country raises
Japanese affiliate sales by 1.1-3.3 % but may decrease US affiliate sales by 1.2 %. Japanese
MNEs that have relatively large sales in less skill abundant countries follow the pattern consistent
with a vertical motive of FDI, whereas the pattern of US MNEs that concentrate in more skill
abundant countries is consistent with a horizontal motive of FDI. This finding may help in

26

The elasticity of Japanese affiliate sales with respect to tax sparing agreements is
exp(0.60)-1 ≈ 82.2 %.

22

explaining why relative skill endowments have little effects on affiliate sales in a pooled sample
and previous literature on the KC model using US MNE data provide mixed support for the
relative importance of vertical motives.
This study also finds that multinational activity is influenced by a variety of policies
such as regional trade agreements, bilateral investment and tax treaties, and tax sparing
agreements, with varying impacts on Japanese and US affiliate sales. For instance, bilateral tax
treaties had negative dynamic effects on Japanese MNEs but increase US affiliate sales. Tax
sparing agreements raise Japanese affiliate sales by 0.8 % in signatory countries but have noeffect on US MNEs since the US does not grant tax sparing provisions. All of these results
indicate that Japanese and US MNEs may pursue different expansion strategies. Future researchis to explore the particular reasons for this difference between Japanese and US MNE behaviors.
An investigation of more disaggregated data on affiliate sales should also extend this paper’s
findings.

23

Table 1: Variables and Expected Impacts on Affiliate Sales
Skill
Skill × GDP difference
GDP sum
GDP difference squared
Trade cost
Investment cost
Distance
Common language
Land border

+
+
+
+/+
+

Island nation
Landlocked nation
Regional trade agreement
Bilateral investment treaty
Bilateral tax treaty
Tax sparing agreement
Euro currency
Financial crisis

24

+
+
+/+
+/+/-

Table 2: Benchmark Results for Pooled Sample on Japanese and US Affiliate Sales
(1)
(2)
(3)
(4)
WLS
WLS
WLS
GMM a
Sales to Host
Total Sales
Total Sales
Total Sales
and Home
Skill
3968
5742
13439
9077
(9516)(7616)(9424)(31059)Skill × GDP difference-0.070-1.247-3.359**-6.448(1.839)(1.465)(1.641)(6.526)GDP sum
19.66***
19.46***
14.14***
20.75***(1.129)(1.013)(1.071)(2.691)GDP difference squared-0.0009***-0.0008***-0.0002-0.0006(0.0002)(0.0002)(0.0001)(0.0006)
Trade cost
-21.5093.58**
235.6***-175.1(44.79)(42.48)(63.40)(174.7)
Investment cost-178.6***-353.2***-459***
61.78(49.82)(49.63)(77.91)(319.9)Distance-1.645***-1.204***-1.251***-1.092**(0.151)(0.091)(0.117)(0.514)
Common language
8194***
9214***
6729(2323)(2321)(13236)
Land border
67864***
62451***
83015**(7942)(7583)(35605)Island nation
1318
-1903
1346
(951.6)(1404)(6948)
Landlocked nation-4287***-12791***605.9(1010)(2477)(4622)
Regional trade agreement
1833**
5182***
2237(875)(1257)(3743)
Bilateral investment treaty-7203***-4370*-5878(1273)(2471)(3727)
Bilateral tax treaty-6768***-5710***-3882(694.9)(1057)(3963)Tax sparing agreement
6727***
6089***
12764*(1020)(1417)(6603)
Euro currency-6743***-9161***-4940(1992)(2362)(5165)
Financial crisis
-2594
-2209
1941
(4969)(3880)(2682)
Number of observations
827
827
567
827
0.61
0.76
0.72
R2
Root MSE
14630
11525
12139
0.54
Hansen test (p-value) b
Serial correlation test (p-value) c
0.14
Notes: Robust standard errors shown in parentheses; two-step standard errors in GMM corrected for asmall sample bias; the weight in WLS being the squared sum of GDP; intercepts and dummies forJapanese MNE and year unreported.
*** Significant at 1 %; ** significant at 5 %; * significant at 10%.
a: The number of instruments and country pairs are 50 and 84, respectively.
b: The null hypothesis is that the instruments are not correlated with the residuals.
c: The null hypothesis is that the errors in the differenced equation have no second order serial
correlation

25

Table 3: Log Specification for Pooled Sample on Japanese and US Affiliate Sales
(1)
(2)
(3)
(4)
WLS
WLS
WLS
GMM a
Sales to Host
Total Sales
Total Sales
Total Sales
and Home
Skill1.291***-0.752**0.008-1.442(0.392)(0.316)(0.270)(2.723)
GDP Host
0.903***
1.098***
0.762***
0.829**(0.047)(0.042)(0.042)(0.330)Trade cost
-0.249-0.1720.363***-0.105(0.163)(0.160)(0.119)(0.461)
Investment cost
-0.401*-0.423*-0.916***-0.185(0.213)(0.219)(0.177)(0.679)Distance-0.843***-0.682***-0.468***-0.734***(0.063)(0.080)(0.061)(0.276)
Common language
0.319**
0.253**
0.036(0.149)(0.108)(0.419)Land border-0.0770.985***
0.133(0.240)(0.183)(0.685)Island nation
1.161***
0.687***
1.224***(0.111)(0.093)(0.309)Landlocked nation
0.044-0.729***-0.242(0.246)(0.182)(0.706)
Regional trade agreement
0.343***
0.361***
0.323(0.107)(0.083)(0.267)
Bilateral investment treaty-0.614***-0.239*-0.517(0.171)(0.133)(0.570)
Bilateral tax treaty-1.001***-0.896***-0.577(0.110)(0.091)(0.441)
Tax sparing agreement
1.923***
0.685***
1.395**(0.164)(0.139)(0.630)Euro currency-0.601***-0.201-0.325(0.215)(0.176)(0.334)
Financial crisis
0.672*
0.127
0.069(0.370)(0.308)(0.153)
Number of observations
827
827
567
827
0.48
0.66
0.62
R2
Root MSE
1.48
1.20
0.78
0.29
Hansen test (p-value) bcSerial correlation test (p-value)
0.59
Notes: Robust standard errors shown in parentheses; two-step standard errors in GMM corrected fora small sample bias; the weight in WLS being a logarithm of host GDP; intercepts and dummies forJapanese MNE and year unreported; all regressors (except dummies) defined in logarithms.
*** Significant at 1 %; ** significant at 5 %; * significant at 10%.
a: The number of instruments and country pairs are 42 and 84, respectively.
b: The null hypothesis is that the instruments are not correlated with the residuals.
c: The null hypothesis is that the errors in the differenced equation have no second order serial
correlation

26

Table 4: Log Specification for Separate Samples on Japanese and US Affiliate Sales
(1)
(2)
(3)
(4)
WLS
WLS
FE
FE
Japan
US
Japan
US
Skill
1.057*-1.198***3.268***
1.140(0.542)(0.424)(1.044)(1.298)GDP host
1.537***
1.063***
0.585
1.952***(0.094)(0.056)(0.456)(0.211)
Trade cost
-0.842***-0.091-0.148-0.126**(0.295)(0.165)(0.126)(0.059)Investment cost
-0.596-0.375*-0.670*-0.332***(0.362)(0.221)(0.355)(0.128)Distance-0.370***-0.407***(0.118)(0.091)
Common language
0.491***(0.151)Island nation
1.132***
0.265*(0.211)(0.153)Landlocked nation
0.467-0.234(0.415)(0.209)NAFTA
0.483
0.655**
0.316*
0.194***(0.294)(0.278)(0.180)(0.074)EU-0.724***
0.523***
0.229**
0.124**(0.245)(0.165)(0.115)(0.061)AFTA
1.809***
1.449***
0.479***
0.189**(0.255)(0.145)(0.168)(0.091)
Mercosur-0.2590.287**-0.108-0.155**(0.335)(0.137)(0.126)(0.077)
Bilateral investment treaty-1.009***-0.318**0.198
0.540***(0.266)(0.142)(0.170)(0.107)
Bilateral tax treaty-1.539***-0.465***-0.298**0.142**(0.205)(0.114)(0.143)(0.066)
Tax sparing agreement
1.562***
0.598***(0.184)(0.188)Euro currency-0.338-0.202-0.254-0.170***(0.351)(0.219)(0.166)(0.045)
Financial crisis-0.3880.030-0.160-0.088(0.523)(0.234)(0.095)(0.115)
Number of observations
438
384
438
384
Number of country pairs
41
41
2
R
0.64
0.73
0.23
0.78
Root MSE
1.34
0.70
0.50
0.17
Notes: Robust standard errors shown in parentheses; the weight in WLS being a logarithm of hostGDP; intercepts and year dummies unreported; all regressors (except dummies) defined inlogarithms.
*** Significant at 1 %; ** significant at 5 %; * significant at 10%.

27

Data Appendix
Table A1: List of countries
Argentina
Australia
Austria
BelgiumBrazilCanadaChile
China
Colombia
Czech Republic
Denmark

Egypt
FinlandGermany
GreeceHong Kong
Hungary
IrelandIsrael
Italy
Japan
Korea

Table A2: Data sources
VariableAffiliate total sales
Affiliate sales to home andhost countries
Skill
GDP
Trade cost
Investment cost
Distance
Common language
Land borderIsland nation
Landlocked nation
Regional trade agreement
Bilateral Investment treaty
Bilateral tax treaty
Tax sparing agreement
Euro currency
Financial crisis

Malaysia
MexicoNetherlands
New Zealand
NorwayPakistan
Philippines
PolandPortugal
RussiaSingapore

Slovak RepublicSouth Africa
Spain
SwedenSwitzerland
TaiwanThailandTurkeyUnited Kingdom
United States
Venezuela

SourceJapanese affiliate data from the Research Institute of Economy,
Trade and Industry (RIETI), Japan;
U.S. affiliate data from U.S. Bureau of Economic Analysis
Same as above
Yearbook of Labor Statistics, International Labor Organization
World Development Indicator, World BankWorld Competitiveness Report and World Competitiveness
Yearbook, World Economic Forum and IMD
Same as above
Raymond Robertson's website(http://www.macalester.edu/~robertson/)Same as above
CIA’s World Factbook
Same as above
Same as above
WTO website (http://www.wto.org/index.htm)
Bilateral Investment Treaties 1959-1999, UN (2002)(www.unctad.org/en/docs/poiteiiad2.en.pdf)
International Bureau of Fiscal documentation;
Blonigen and Davies (2004)
Azémar et al. (2006); OECD (1998)
EU website (http://europa.eu/index_en.htm)
Lipsey (2001)

28

Table A3: Summary statistics
VariableObs.
Affiliate total sales
Sales to host and home
Japanese affiliate sales
US affiliate sales
Skill
GDP sum
GDP difference
GDP host country
Trade cost
Investment cost
Distance

827
567
438
384
827
827
827
827
827
827
827

Affiliate total sales
Sales to host and home
Japanese affiliate sales
US affiliate sales
Skill
GDP host country
Trade cost
Investment cost
Distance

827
567
438
384
827
827
827
827
827

Mean
Std. Dev.
Level specification
21364
39071
20782
36177
13611
34477
30482
42168
1.046
0.170
6896
2452
5856
2496
519.7
1219
29.38
13.09
31.51
11.38
8779
3860
Log specification
8.557
2.038
9.090
1.272
7.806
2.189
9.460
1.354
0.032
0.160
5.375
1.127
3.272
0.486
3.381
0.379
8.943
0.605

29

Min.

Max.

1.936
299.0
1.936
676.7
0.501
3945
-5282
20.22
3.70
12.29
733

242349223707242349195949
1.792
14782
9982
10032
81.41
62.97
18373

0.661
5.700
0.661
6.517
-0.692
3.007
1.308
2.508
6.597

12.39812.31812.39812.186
0.584
9.214
4.399
4.143
9.819

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