Firms in the Global Economy

Firms in the Global Economy:
Export Decisions, Outsourcing,
and Multinational Enterprises
In this chapter, we continue to explore how economies of scale generate
incentives for international specialization and trade. We now focus on
economies of scale that are internal to the firm. As mentioned in the previous
chapter, this form of increasing returns leads to a market structure that features
imperfect competition. Internal economies of scale imply that a firm’s average
cost of production decreases the more output it produces. Perfect competition
that drives the price of a good down to marginal cost would imply losses for
those firms because they would not be able to recover the higher costs incurred
from producing the initial units of output.1 As a result, perfect competition would
force those firms out of the market, and this process would continue until an
equilibrium featuring imperfect competition is attained.
Modeling imperfect competition means that we will explicitly consider the
behavior of individual firms. This will allow us to introduce two additional characteristics
of firms that are prevalent in the real world: (1) In most sectors, firms
produce goods that are differentiated from one another. In the case of certain
goods (such as bottled water, staples, etc.), those differences across products
may be small, while in others (such as cars, cell phones, etc.), the differences are
much more significant. (2) Performance measures (such as size and profits) vary
widely across firms. We will incorporate this first characteristic (product differentiation)
into our analysis throughout this chapter. To ease exposition and build
intuition, we will initially consider the case when there are no performance differences
between firms. We will thus see how internal economies of scale and
product differentiation combine to generate some new sources of gains of trade
via economic integration.
We will then introduce differences across firms so that we can analyze how
firms respond differently to international forces. We will see how economic
1Whenever average cost is decreasing, the cost of producing one extra unit of output (marginal cost) is lower
than the average cost of production (since that average includes the cost of those initial units that were produced
at higher unit costs).
156 PART ONE International Trade Theory
integration generates both winners and losers among different types of firms. The
better-performing firms thrive and expand, while the worse-performing firms
contract. This generates one additional source of gain from trade: As production
is concentrated toward better-performing firms, the overall efficiency of the
industry improves. Lastly, we will study why those better-performing firms have
a greater incentive to engage in the global economy, either by exporting, by outsourcing
some of their intermediate production processes abroad, or by becoming
multinationals and operating in multiple countries.
LEARNING GOALS
After reading this chapter, you will be able to:
• Understand how internal economies of scale and product differentiation
lead to international trade and intra-industry trade.
• Recognize the new types of welfare gains from intra-industry trade.
• Describe how economic integration can lead to both winners and losers
among firms in the same industry.
• Explain why economists believe that “dumping” should not be singled out
as an unfair trade practice, and why the enforcement of antidumping laws
leads to protectionism.
• Explain why firms that engage in the global economy (exporters, outsourcers,
multinationals) are substantially larger and perform better than firms that do
not interact with foreign markets.
• Understand theories that explain the existence of multinationals and the
motivation for foreign direct investment across economies.