Academic journal article East Asian Economic Review

Correlation between Sales of Foreign Affiliates and Productivity of Multinational Firms: Evidence from Korean Firm-Level Data*

Academic journal article East Asian Economic Review

Correlation between Sales of Foreign Affiliates and Productivity of Multinational Firms: Evidence from Korean Firm-Level Data*

Article excerpt

(ProQuest: ... denotes formulae omitted.)

I. Introduction

Korea's multinational enterprises (MNEs) have consistently increased their foreign direct investment (FDI) since 1994.1 In 2010, the FDI outflow of Korean MNEs was 23.2 billion dollars, and 2,855 foreign affiliates were newly established by Korean MNEs.2

In order to explain FDI and the multinational activities of MNEs, recent literature in international economics has emphasized differences in firm productivity, suggesting that it is productivity differences between MNEs that impact the parent firms' decisions on whether to export or to directly invest in foreign countries. According to the seminar paper of Helpman et al. (2004), only firms that are productive enough to control fixed costs of investment, such as construction and management costs in foreign markets, are able to establish foreign affiliates. Yeaple (2009) finds that the more productive U.S. firms show greater scope (number of affiliates) and scale (size of affiliates) in their multinational activities.

In this paper, when analyzing Korean data, we note that Korean MNEs' investments tend to be concentrated in a limited number of countries, such as China or the U.S. Therefore, while following the literature on productivity heterogeneity as a determinant of FDI choices, we further investigate whether the FDIs of Korean MNEs have been concentrated in one country. In particular, we choose China as a destination for FDI, since it is known that the main host country for Korean FDI has been China. In this context, we begin with an idea that the establishment of multiple affiliates in a specific host country may also be related to the parent firm's productivity. In so investigating this idea, we will compare the productivity levels of two groups of MNEs, that is, companies with single affiliates and those with multiple affiliates. In particular, we will examine the correlations between the sales of foreign affiliates and productivity levels of Korean MNEs for each of the two groups.

Our main empirical result in this paper suggests that Korean MNEs that are more productive are more likely to enlarge the number of affiliates in the host country. We conjecture that regionally concentrated FDIs of an MNE may yield benefits related to information and network advantages.3 According to existing theories such as Helpman et al. (2004), firms that are more productive invest in foreign markets, rather than selling in the domestic market, and they are able to cover the higher fixed cost required for foreign investments. That is, the firm may need to incur higher fixed costs when it invests in multiple affiliates rather than in a single affiliate. Regionally concentrated FDIs, however, can help in reducing the cost incurred for two reasons. First, the firm can save the fixed cost of information, because it is relatively easy for an affiliate to obtain information from existing affiliates about the same host country. Second, the firm may enjoy complementarity in production processes among its affiliates located in the same host country, as compared to the case where FDIs are spread to many countries.

We organize this paper as follows. First, in section 2, we will review the existing literature regarding firm heterogeneity and FDI. We will then move on to show a data description for Korean MNE activities in section 3. We will also begin our empirical studies with Korean MNEs' data and investigate how firms invest in international markets in general. Section 4 will focus on explaining the distribution of Korean affiliates located in China and compare the sales of an affiliate and the productivity of its Korean counterpart. We conclude in Section 5 by summarizing the results and commenting on some limitations of the current analysis.

II. Literature Review

There are many existing studies on theoretical models and empirical evidence about the relationship between productivity differences and MNEs' multinational activities. …

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