Service Multinationals in the Theory of International Trade

This paper examines the consequences of liberalizing trade in producer services through multinationals. The formation of multinationals in the present paper is not necessarily associated with the failure of factor price equalization. Similar economies in terms of factor endowments engage in two-way intra-industry foreign direct investment. However, the notion of comparative advantage is crucial in predicting the direction of trade and foreign direct investment when two countries differ in factor endowments. In a two-country general equilibrium model of international trade, liberalizing both trade and foreign direct investment gives rise to welfare gains.