A Linder hypothesis for foreign direct investment. Working Paper 17550

We study patterns of FDI in a multi-country world economy. We develop a model featuring non-homothetic preferences for quality and monopolistic competition in which specialization is purely demand-driven and the decision to serve foreign countries via exports or FDI depends on a proximity-concentration trade-o¤. We characterize the joint patterns of trade and FDI when countries di¤er in income distribution and size and show that FDI is more likely to occur between countries with similar per capita income levels. The model predicts a Linder Hypothesis for horizontal FDI, which is consistent with the patterns we \u85nd using establishment-level data on multinational activity