Title: Essays on international trade and foreign direct investment
Description: This dissertation consists of three research papers that build upon the recent work of Eaton and Kortum (2002) and Melitz (2003). Chapter 1 formulates an extension of the Eaton-Kortum model that facilitates quantification of the importance of different sources of comparative advantage for industry trade patterns and country welfare. In the model, comparative advantage is driven by the interaction of country and industry characteristics, so that countries specialize in those industries whose production needs they can best satisfy with their endowment mix, institutional environment, and technological strengths. I estimate the model via a simulated method of moments approach, to account for the prevalence of zero observations in the trade data. Calibrating the model with these estimates, I examine the shift in industry composition when countries raise their factor endowments or improve their institutions, and quantify the welfare gains from such policy moves. Chapter 2 analyzes the efficacy of subsidies to FDI, within a Melitz framework where firms are heterogenous in their productivity levels. In this setting, I show formally that a small subsidy to attract multinational firms generates consumption gains in the FDI host country that exceed the cost of financing the subsidy through a tax on domestic labor. This welfare improvement is driven by a selection effect, since the subsidy induces only the most productive exporters to switch to servicing the host country market via FDI instead.

Chapter 3 explores the effects of financial development in the FDI host country on multinational sales activity. Using data on US multinational activity abroad, we find that stronger host country financial development tends to lower the share of affiliate sales that remain in the local market, while increasing the share of sales to third-country destinations. We provide a three-country model with heterogeneous firms to rationalize these observations: Host countries with better financial development foster entry by domestic firms, resulting in a more competitive local market. This leads multinationals to orient their operations away from horizontal sales to the local market, towards export-platform sales to third-country markets instead.