Intra-Firm Trade and Contract Completeness: Evidence from Japanese Foreign-Affiliated Firms

Abstract

The issue on growth and its variations of the intra-firm trade of intermediate inputs are of great interest in international economics. Recently, many economists have stepped forward to explain this issue. However, traditional trade theory cannot explain the choice between intra-firm trade with vertical integration and international outsourcing. Thus, researchers are motivated to incorporate the concepts from industrial organization and contract theory to explain the organizational structure of firms. Using micro data at the affiliate-firm level, this chapter examines the determinants of intra-firm trade by shedding light not only on factor prices and trade costs but also on organizational structure in terms of the ownership of overseas plants and the control over intermediate inputs for further processing. Since organizational structure and intra-firm trade are jointly determined, we adopt instrumental variable (IV) regressions into our analysis and treat the choice of purchasing managers as an endogenous variable. The results suggest that the control over input decisions critically affects the intra-firm trade of intermediate inputs.

Appendix: Data Description

This chapter uses the SOBA micro database, which is a firm-level survey by the Research and Statistics Department, Ministry of Economy, Trade and Industry, in the Government of Japan. This survey obtains basic information on the activities of the overseas affiliates of Japanese firms. The parent companies constitute Japanese corporations, which own or have owned overseas affiliates in the past, as of the end of March (excluding companies in the finance and insurance industry and the real estate industry). The survey includes various items on affiliate characteristics, such as the first year of establishment, the breakdown of sales and purchases, employment, costs, and R&D.

Furthermore, to control for parent firm characteristics, we link the affiliate survey, SOBA, with the firm-level survey, Kigyo Katsudo Kihon Chosa (Basic Survey of Japanese Business Activities and Structures; hereafter, BSJBSA) by Japan’s Ministry of Economy, Trade, and Industry. This survey was first conducted in 1991 and then conducted annually after the 1994 survey. This survey covered all firms with more than 50 employees and capitalization of at least 30 million yen in mining, manufacturing, wholesale and retail trade, and some service sectors.

We omitted the manufacturing affiliates whose primary activities were not regarded as “production” from our sample. Since SOBA does not request a breakdown of shipments, the industry classifications are not always reliable. In fact, there are many affiliates who belong to the manufacturing sector, but they have an extremely low value-added ratio. Probably, these affiliates mainly engage in wholesale activities, but they report their industry classification as the manufacturing sector. Fortunately, the survey includes qualitative inquiries about their current and future primary activities, such as “production,” “research and development,” “wholesale,” and “retail.” We restrict our sample to the affiliates belonging to the manufacturing sector and report their current primary activities as “production.”