Vertical Foreign Direct Investment:
Evidence from Japanese and U.S. Multinational Enterprises

Kiyoyasu Tanaka

March 2009


Foreign direct investment (FDI) has rapidly increased in developing countries since the 1990s, but formal evidence for vertical FDI has been surprisingly mixed. This paper empirically reconsiders the factor-proportions hypothesis by exploring the role of host country’s relative skill endowments in offshore production of multinational enterprises (MNEs). Using panel data on sales of foreign affiliates by Japanese and U.S. MNEs in the 1990s, I find that relative skill abundance has a large negative impact on Japanese affiliate sales, but little effects on U.S. affiliate sales. Robust to a wide variety of sensitivity checks, the results strongly support vertical FDI in the case of Japanese MNEs, but not U.S. MNEs. Because the dominant view in favor of horizontal FDI against vertical FDI in the previous literature results primarily from U.S. data, I empirically demonstrate that data sources on MNEs could partly explain weak evidence for vertical FDI.

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