Foreign location choices by U.S. multinational companies.
Mataloni, Raymond J., Jr.
THE INCREASING globalization of the U.S. economy has heightened
interest in the process and criteria by which U.S. multinational
companies (MNCs) select locations for investments abroad. Although this
issue is not new, it has become more relevant. Continuing reductions in
barriers to foreign trade with, and investment in, emerging
markets--such as China, India, Mexico, and Eastern European
countries--have given MNCs more options, increasing their opportunities
to lower costs by expanding production abroad. The attractiveness of
establishing new foreign production facilities may be further enhanced
by concurrent increases in manufacturing and technological capabilities
that have occurred in some of these countries. Moreover, economic theory
suggests that MNCs can heighten their efficiency by creating
international production networks in which high value-added activities,
such as technical production processes, are performed in countries that
are relatively well endowed with highly skilled workers, and lower
value-added activities, such as assembly, are performed in countries
where wages are lower.
Bureau of Economic Analysis (BEA) data show that as of 2005, more
than 70 percent of worldwide production by MNCs occurs in the United
States. Of the 28 percent of production that occurs abroad, over 80
percent occurs in other high-income countries (table 1). Although the
global allocation of MNC production has shifted moderately toward lower
income countries in recent decades, the production that occurs in those
countries is overwhelmingly directed toward the local market rather than
being part of an international production network. In China and India,
for example, sales to local customers account for nearly three-quarters
of total sales by affiliates of U.S. MNCs. Therefore, if MNCs are not
primarily locating foreign operations in low-wage countries, there must
be attributes of host countries other than wages that influence their
location decisions. A related issue is whether location at tributes are
considered only at the national level or also at some other geographic
level, such as the regional level.
These issues are addressed in the BEA paper "Do U.S.
Multinationals Engage in Sequential Choice? Evidence from New
Manufacturing Operations in Europe." (1) The study examines the
determinants of the location of new manufacturing operations of MNCs in
seven European countries over the period 1989-2003. It examines both how
U.S. companies approach the choice process and which location attributes
they consider.
The study's main conclusions are as follows:
* MNCs appear to engage in a sequential choice process in which
they first select a country based on national attributes and then a
region within that country based on regional attributes.
* Productivity-enhancing attributes (such as proximity to
suppliers, the availability of highly skilled workers, and the presence
of an extensive transportation infrastructure) are more important
determinants of location than attributes related to production costs
(such as the availability of low-wage labor).
Data
The data on new manufacturing investments by MNCs used for the
study are from BEA's benchmark and annual surveys of U.S. direct
investment abroad. These surveys collect data on a variety of financial
indicators (such as balance-sheet and income-statement items) and on
other aspects of the operations of U.S. parent companies and their
foreign affiliates (such as employment and international trade). The
data can be used to assess the effects of MNCs on the U.S. economy and
foreign economies. An advantage the BEA survey data have over
private-source data that have been used in other location choice studies
is that they are based on mandatory surveys and are widely considered to
be the most comprehensive and accurate data available on the operations
of MNCs.
The BEA surveys cover the foreign operations of each MNC in a
particular country and in a particular industry (for example, company
XYZ's beverage-manufacturing operations in Spain), but the data do
not provide information on the locations of those operations within the
country. Because a goal of the study was to examine how variation within
countries of various attributes influences location decisions, it was
necessary to identify the regional location of new manufacturing
operations of MNCs. This was accomplished by linking the BEA data with a
private data set, Bureau VanDijk's Amadeus database, which details
the location of businesses within European countries. This linking
exercise shows that new manufacturing operations established by MNCs in
1989-2003 are not evenly distributed among regions. Instead, they tend
to be heavily concentrated in particular regions within foreign host
countries (see the chart). The regional patterns of U.S. investments are
similar to those of European manufacturing in general, suggesting that
all companies--regardless of ownership--choose new industrial locations
in roughly the same manner.
Information on both the national and regional locations of foreign
affiliates allows the study to explore the processes by which MNCs make
location decisions.
Borders matter
An important question is the extent to which national borders
matter when MNCs make location decisions. It is possible that MNCs
consider a region of one European country to be a substitute for a
similar region of another European country. In other words, investors
might consider national borders to be of little importance in light of
factors such as the legal and economic unification of member countries
of the European Union. However, there may be characteristics, either
readily quantifiable (such as the distance to the nearest seaport) or
less quantifiable (such as employee attitudes), that vary or are
perceived to vary significantly across countries.
The study finds that both national and regional attributes matter
and that a plausible description of the choice process involves
companies first selecting a country and then selecting a region within
that country.
Location determinants
Theory suggests that companies choosing locations for new
manufacturing investments will consider location attributes that affect
the expected profitability of the investments. In competitive
industries, the profit-maximizing company will invest in a location
until the additional revenue generated by the last unit of each
productive factor, such as a worker or a machine, is equal to its factor
payment, such as its wage or its rental cost. The factor payment
considered in this study is the average hourly wage paid to workers. (2)
In addition to wages, the study considers other determinants of the
profitability of the investments--namely, measures of worker skill,
market size, tax rates, industrial agglomeration, transportation
infrastructure, and whether the investing firm has prior experience in
the host country. A brief discussion follows of those determinants that
were found to have a significant effect on location choice.
Wages
A surprising result of the study is that MNCs are attracted to
high-wage locations, even after adjusting for location attributes
generally thought to be associated with high-wage levels. All else
equal, one would expect lower wage locations to attract more investment
because the expected return on investment would be higher in those
places. Labor, however, is not a homogeneous resource, and the wage
premium that workers earn in one location over those in another location
may be related to differences in the average level of worker skill in
the two places, or it may be related to other attributes of the
high-wage locations that enhance worker productivity (such as superior
transportation infrastructure) or reduced costs (such as economies of
scale resulting from the presence of an extensive local market for the
firm's output). The study finds that even with a proxy measure of
worker skills and controls for other attributes that could be associated
with high-wage regions, high-wage regions attract more investment than
low-wage regions. (3) One interpretation of this result is that the
control variables do not fully capture the attributes that MNCs seek in
high-wage locations and that the effects of these unspecified attributes
are captured in the unexpected positive effect of the wage variable. The
wage-rate and worker-skill variables were found to be significant at the
regional level, which is consistent with the limited geographic mobility
of workers and the need for companies to hire from the local labor pool.
(4)
[ILLUSTRATION OMITTED]
Agglomeration
The study found that "industrial agglomeration" is an
important determinant of new manufacturing investments, as have most
other studies of industrial location. This term refers to the tendency
for certain geographical locations to attract a disproportional share of
firms, especially in certain industries. MNCs are attracted to European
countries and to regions within those countries that have a relatively
high proportion of firms in the investing U.S. company's industry
(for example, Germany's North-Rhine Westphalia region has
Europe's largest concentration of chemical manufacturing). At the
national level, the attraction might be related to conditions in the
host country (such as innovative competitors and demanding customers)
that drive firms in that country and in that industry to excel. (5) At
the regional level, the attractions might include proximity to
suppliers, the availability of workers possessing industry-specific
skills, and the ability to acquire best practices by imitating local
competitors and suppliers.
Transportation
The study found that transportation infrastructure is an important
determinant of new manufacturing investments at the regional level.
Manufacturers rely heavily on transportation and other infrastructure
(such as telecommunications) to interact with suppliers and customers.
The importance of these interactions is evident in the BEA data on the
operations of foreign affiliates of MNCs; in 2005, inputs from suppliers
accounted for 72 percent of the value of goods and services sold or
added to inventory by European manufacturing affiliates. The study found
that regions with relatively well-developed road networks attract more
investment. However, the measure of transportation infrastructure was
not found to be significant at the national level.
Conclusion
To conclude, the results of this study inform the debate on the
effects of MNCs on their home and host economies by examining how wages
and other attributes of countries and the regions within them influence
their location choices. Despite anecdotal evidence of companies using
relatively low-wage European countries as "export platforms"
to the rest of the European Union, this study finds that MNCs were
actually most attracted to high-wage regions of Europe. Other attractive
location attributes include industrial agglomeration and extensive
transportation infrastructure. The study also sheds light on the
decision processes of MNCs. Rather than simultaneously deliberating over
all attributes of all possible regional locations within Europe, MNCs
appear to engage in a sequential choice process in which a country is
first selected based on one set of attributes and then a region within
that country is selected based on another--largely separate--set of
attributes. Future extensions of this study may include expanding the
geographic coverage of the data to include more European countries,
including countries in Eastern Europe.
(1.) This paper is available on the BEA Web site
<www.bea.gov> under "Papers and Working Papers."
(2.) The cost of capital is not considered, because capital tends
to be much more geographically mobile than labor. So one might expect
its price to be more equal across locations than that of a more immobile factor like labor.
(3.) The proxy for the average level of worker skill is the
percentage of the workforce with at least a secondary education.
(4.) In an alternative specification of the sequential choice model
not reported in the paper, the evaluation of wage rates was modeled at
the national level rather than at the regional level, but the variable
was not found to have a significant effect.
(5.) Michael E. Porter, The Competitive Advantage of Nations (New
York, NY: Free Press, 1990).
The author is an economist at BEA. The opinions expressed in this
article represent his views; they are not necessarily those of BEA or
the U.S. Department of Commerce.
Table 1. Location of Production by U.S. Multinational Companies
[Percent]
Share of worldwide Share of foreign MNC
MNC total production
United Foreign High- Other
States counties income countries
countries
1989 76.6 23.4 85.7 14.3
1994 76.5 23.5 84.3 15.7
1999 77.2 22.8 83.8 16.2
2004 72.6 27.4 81.2 18.8
2005 72.3 27.7 80.2 19.8
NOTE. The shares for all the years except 2005 are based
on data from benchmark surveys, or censuses, of U.S.
direct investment abroad.
