The "Proximity-Concentration" Tradeoff in a Risky Environment

This paper analyzes the impact of country specific risk on a firm's choice between serving a foreign market through exports or affiliates sales. We find that country pairs with less correlated business cycles trade more, relative to multinational production. Moreover, the stochastic properties of world output fluctuations affect the cross country patterns of trade flows and foreign affiliate sales. Using detailed U.S. data on trade and affiliate sales from the Bureau of Economic Analysis, we find empirical support for the predictions of the model. Our estimates suggest that an increase in one standard deviation in the co-movement between the United States and a trading partner reduces the ratio of exports to sales from the United States to that country by more than half of a standard deviation, while an increase of one standard deviation in the distance between both countries decreases such ratio by one fourth of standard deviation.