DP7553 Gravity in the Weightless Economy

Author(s): Wolfgang Keller , Stephen R Yeaple

Publication Date: November 2009

Keyword(s): communication , foreign direct investment , intra-firm trade , Multinational firms , noncodified knowledge , offshoring , technology transfer , vertical production sharing

JEL(s): F1 , F2 , O23

Programme Areas: Development Economics , Industrial Organization , International Trade and Regional Economics

Link to this Page: www.cepr.org/pubs/dps/DP7553.asp

This paper studies the international mobility of technology through the lens of multinational firms. We show that gravity applies to the activity of multinational firms, and the strength of gravity is greatest in technologically-complex, research and development intensive industries. To explain gravity in the weightless economy, we develop a model in which a multinational's production can be fragmented into intermediates that vary in the codifiability of their technology. Poorly codified technology requires face-to-face communication to transfer accurately, leading to production inefficiencies that can be avoided if an affiliate instead imports intermediates embodying this technology from its parent firm. Because intermediate input trade incurs shipping costs, affiliates' sales are subject to the force of gravity, and this force is strongest in technologically complex industries. An additional implication of this mechanism is that affiliates are more constrained in their ability to substitute local production for intermediate imports in technologically complex industries. We confirm these predictions and show that trade costs increase the average technological complexity of intra-firm trade. Our analysis offers a new perspective on the mobility of technology, which is a topic crucial to a wide range of fields in economics.