Where Does the Model Fail?

We have shown that our framework can reasonably simulate Japanese multinational activities which are based on entry and sales conditions dictated by the model. Because the model is constructed to capture only key elements of multinational behaviors in a simple way, our model does not take into account other potentially important motivations for FDI. In particular, a critical feature of multinationals that is missing in our model is firm exporting activity. To assess how this simplification of the model affects its ability to replicate Japanese multinational behavior, we focus exclusively on vertical oriented firms for which more than 50% of sales by their foreign affiliates are yielded from exports to Japan.

We compare vertical FDI firms in the data with firms that are simulated as prescribed by the model. Figure 7 shows that real vertical activity is systematically different from the simulations of the model. Real Japanese vertical firms activity is much smaller than what is found by our simulated firms for affiliate production in the United States, Europe, and other markets more generally classified as market-seeking destinations rather than factor-seeking. By contrast, we find that real Japanese vertical firm activity is much larger than our simulated firm activity for China and Vietnam, countries that are more likely to be driven by factor cost differentials.

7. Conclusion

This research introduces a new micro-simulation framework for examining multinational activity across home and host countries. Based on the structural approach of Eaton, Kortum, and Kramarz (2010), the model is designed to simulate entry and sales activity of heterogeneous firms across asymmetric countries in the presence of fixed entry costs and costly technology/management transfer. The model yields empirical implications consistent with Japanese multinational activities in 2006.         upward (Levchenko and Giovanni, 2010). While our model ignores exporting activity, increasing levels of trade during the past decade could increase this bias.

Matching the model with data on Japanese multinationals, we estimated the structural parameters with simulated method of moments and found the parameter estimates to be in line with previous studies and robust to different estimation designs. The fully quantified model allows us to simulate entry and sales of foreign affiliates of Japanese firms.

Through internal and external validation exercises, we rigorously tested how well the model performed in replicating real multinational activity. Our results demonstrated that the model could strongly replicate in-sample moments. Multinational activity not conditioned in the estimation strategy also performed considerably well. While our 1996 out-of-sample predictions contained slight deviations from the data, the overall simulations suggest that the model is externally consistent with the Japanese multinational activity from a decade prior. We also found several shortcomings of the model. First, large firms invest in too many countries, and small firms invest in too few. Second, we tend to under-simulate the level of sales of Japanese multinationals in both home and foreign markets. Lastly, the model poorly explains vertically motivated multinationals. Nonetheless, the predictive power of the model was found robust to the estimation strategy, and yields considerable support for its ability to replicate Japanese multinational activities.

Our research highlights the richness of our simulation framework for understanding multinational activity. It represents the first step towards developing a framework that can simulate individual multinational activity. There are two potential extensions of this work. First, we can embed the model into a complete general equilibrium to calibrate the rest of Japan’s macro-economy in a global setting. This allows us to conduct counterfactual analysis of the impacts from changes in FDI policies at the individual firm level. The resulting framework will be capable of not only quantifying the economic gains from FDI, but in assessing the distributive impacts of economic integration and its more complex restructuring effects on firms. This future computational model will generate a useful quantitative tool for evaluating policy designs related to FDI. Second, we can incorporate an interaction between trade and FDI in firm-level decisions, which will lead to complex integration strategies of heterogeneous firms servicing foreign markets. Future research is to combine firm exporting and FDI activity in an integrated micro-simulation framework.

Table 1. Firm Entry and Exit by Initial Size in 1996 and 2006

# All Firms # Multinationals

Initial Size Interval (percentile) Year Change from 1996 Year Change from 1996 1996 2006 1996 2006 0 to 10 1,411 1,376 -35 0 3 3 10 to 20 1,410 1,276 -134 5 13 8 20 to 30 1,411 1,178 -233 3 20 17 30 to 40 1,412 1,229 -183 11 40 29 40 to 50 1,412 1,202 -210 16 36 20 50 to 60 1,414 1,191 -223 27 73 46 60 to 70 1,411 1,299 -112 51 113 62 70 to 80 1,413 1,229 -184 75 185 110 80 to 90 1,412 1,409 -3 184 359 175 90 to 99 1,270 1,309 39 464 677 213 99 to 100 141 157 16 124 137 13 Total 14,117 12,855 -1,262 960 1,656 696

Notes: Percentile bins are determined by parent firms' global sales in 1996; all firms include

domestic and multinational firms in manufacturing; we drop firms with missing domestic sales. Source: Basic Survey of Japanese Business Structure and Activities, and Basic Survey of Overseas Business Activities from METI.

Table 2. Firm Growth by Initial Size in 1996 and 2006

Domestic Sales Multinational Sales Global Sales

Initial Size

Interval Year Change from

1996

Year Change from

1996

Year Change from

1996 (percentile) 1996 2006 1996 2006 1996 2006 0 to 10 1.21 1.17 -0.04 0.0 0.0003 0.0003 1.21 1.17 -0.04 10 to 20 2.07 1.87 -0.20 0.001 0.003 0.002 2.07 1.87 -0.20 20 to 30 2.84 2.36 -0.48 0.001 0.01 0.005 2.84 2.37 -0.47 30 to 40 3.73 3.23 -0.50 0.003 0.02 0.02 3.73 3.25 -0.48 40 to 50 4.93 4.15 -0.78 0.01 0.03 0.02 4.94 4.18 -0.76 50 to 60 6.61 5.48 -1.13 0.02 0.07 0.05 6.62 5.55 -1.07 60 to 70 9.23 8.45 -0.78 0.06 0.15 0.09 9.29 8.60 -0.69 70 to 80 14.2 12.2 -2.06 0.11 0.32 0.21 14.4 12.5 -1.85 80 to 90 26.9 26.0 -0.90 0.54 1.31 0.77 27.5 27.3 -0.13 90 to 99 110.4 110.1 -0.30 8.89 16.5 7.66 119.3 126.6 7.30 99 to 100 234.6 212.1 -22.5 38.0 76.5 38.4 272.7 288.6 15.9 Total 416.8 387.1 -29.7 47.7 94.9 47.2 464.5 482.0 17.5

Notes: Percentile bins are determined by parent firms' global sales in 1996; sales are in trillions of 2006 Japanese Yen; domestic sales include purely domestic sales of all firms; multinational sales include only sales of foreign affiliates by multinational firms.

Table 3: Japanese Firms Investing in the Top 5 Countries

Market Number of Multinationals Fraction of Multinationals

China 1191 0.59 United States 652 0.32 Thailand 525 0.26 Taiwan 318 0.16 Indonesia 311 0.15 Total 1972

Note: Total indicates the total number of multinational parent firms that invest in these top 5 markets.

Table 4: Japanese Firms Investing in the Strings of Top 5 Countries

If FDI in each string is independent in the top 5 Market String* Number of Multinationals Predicted Probability Number of Multinationals CHN 479 10.4% 211 CHN-USA 60 5.1% 104 CHN-USA-THA 29 1.9% 38 CHN-USA-THA-TWN 6 0.4% 7 CHN-USA-THA-TWN-IND 4 0.1% 1 Total 578 361

Multinationals in Pecking Order 29.3% 18.3%

Table 5. Estimation Results of Parameters

(1) (2) (3) (4)

Markets Markets with over 10 _affiliates All Markets Markets with over 10 _affiliates Markets with over 10 _affiliates

Year 2006 2006 2006 1996

Moments All All No Pecking Order String All

Variable

1.99 2.12 1.95 2.13

(size dispersion) (0.43) (0.95) (0.64) (0.53)

1.64 1.64 1.66 1.36

(variance of sales shock) (0.07) (0.10) (0.08) (0.11)

0.39 0.52 0.34 0.45

(variance of entry shock) (0.31) (0.16) (0.42) (0.43)

-0.62 -0.55 -0.64 -0.99

(correlation of sales and entry shocks) (0.34) (0.25) (0.51) (0.56)

Notes: figures indicate parameter estimates of each variable for a minimum value of the objective function; parentheses are bootstrapped standard errors from initial fixed parameter estimates with 1000 repetitions; each bootstrapping simulates 100,000 firms and uses randomly sampled Japanese firms.

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