Asymmetric effects of trade costs on entry modes: Firm level evidence

Standard foreign direct investment (FDI) theory suggests that falling trade costs should discourage horizontal FDI. Most FDI is horizontal. Yet, the world witnessed an FDI boom in 1990s, a period of striking falls in trade barriers. This paper carries out an empirical analysis with rich, firm-level data on the activities of Swedish multinationals around the globe in manufacturing sectors from 1987 to 1998 to shed light on this apparent conflict. The analysis is based on the predictions of a recent literature with an industrial organization (IO) angle: Trade costs have asymmetric effects on foreign expansion modes. This view posits that falling trade costs encourage entry realized as mergers and acquisitions (M&As), one of the potential explanations for the conflict between received theory and recent trends in FDI. Empirical results confirm the findings of this recent literature and add to it by testing its extensions.

► The paper investigates the role of trade costs in the entry mode choice of MNEs using firm-level data. ► Results show that falling trade costs increase the likelihood of cross-border M&As. ► Cross-border M&As and exporting are complements not substitutes in their response to trade costs. ► Firms with bigger size or many affiliates are relatively invulnerable to changes in trade costs.