EFB336 Chap.4 Firm Trade, Outsourcing and Multinationals
Firm Trade, Outsourcing and Multinationals
Firms differ in productivity, and cross-border activity carries fixed as well as variable costs. That combination creates selection: low-productivity firms serve no market or only the home market, more productive firms export, and the most productive may bear the larger commitment required for foreign production. Outsourcing and foreign direct investment then depend on control, contracting and trade costs.
The framework explains why liberalisation reallocates market share within an industry as well as between industries.
What this chapter covers
- 01
Firm productivity heterogeneity
- 02
Fixed and variable trade costs
- 03
Domestic service and export cut-offs
- 04
Foreign direct investment choices
- 05
Outsourcing versus internal control
- 06
Reallocation after trade-cost changes
Worked example · free
Rank market-entry choices by productivity
- +1The low-productivity firm cannot spread an additional fixed cost over enough sales and remains domestic or exits.
- +1The medium-productivity firm can cover the export fixed cost and serves the foreign market through exports.
- +1The high-productivity firm can justify the larger foreign-production commitment and may choose direct investment.
- +1The ranking is conditional on market size, shipping costs and the relative fixed costs of each mode.
Key terms
- Export cut-off
- The productivity threshold above which a firm can profitably cover the fixed cost of exporting.
- Foreign direct investment
- Cross-border ownership or control of productive activity rather than sales through exports alone.
- Outsourcing
- Purchasing an activity or input from an independent supplier rather than performing it within the firm.
Firm Trade, Outsourcing and Multinationals FAQ
Why do only some firms export?
Exporting often requires market research, distribution, compliance and other fixed costs in addition to shipping costs. Productive firms generate enough operating profit to cover those costs. Less productive firms may remain domestic even when every firm faces the same foreign market price.
When can foreign production beat exporting?
Foreign production becomes attractive when avoiding transport and border costs is valuable enough to cover its larger fixed commitment. Large destination demand and high shipping costs support that choice. Coordination, contracting and loss-of-control risks can still make exports preferable.
How does lower trade cost change an industry?
Lower trade costs expand foreign opportunities for productive exporters and intensify competition at home. Market share shifts toward more productive firms, while marginal firms may contract or exit. The resulting aggregate productivity gain comes from reallocation as well as improvement within continuing firms.
Exam move
Use the productivity ladder as a reasoning device, not a list to recite. Begin with operating profit before each extra fixed cost. A low-productivity firm may be unable to cover the cost of serving even its home market.
A stronger firm can operate domestically; a more productive firm can spread the fixed cost of foreign distribution over sufficient sales; and the largest surplus may support the greater commitment associated with foreign production. Redraw the ladder under a larger destination market and under lower shipping cost, noting which cut-offs should move. Next, compare entry modes with a common ledger.
Record the fixed commitment, per-unit trade cost, control over technology or quality, and exposure to contracting problems for domestic production plus exports, outsourced supply and owned foreign production. Apply the proximity-concentration trade-off: producing near customers avoids repeated border costs, while concentrating production preserves plant-level scale.
Do not treat foreign direct investment as the inevitable highest stage because modest demand or difficult management can leave exports preferable. For liberalisation essays, trace both between-market and within-industry change. Productive exporters expand, marginal domestic firms face stronger import competition, some firms exit and labour or capital reallocates toward survivors.
Aggregate industry productivity can rise through this selection even if no firm discovers a new technology. Practise two short calculations that compare annual variable-cost savings with an additional fixed commitment, then vary market size to locate the break-even point.
Finally, add contracting detail to an outsourcing case: specify what cannot be written or enforced, which party makes a relationship-specific investment and how ownership changes incentives. A complete answer chooses the relevant margin, states the cost comparison, predicts which firms select into the activity and explains how the industry composition changes.
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