The objective of this report is to understand the role of multinational enterprises (MNEs) and production networks in economic activity, and to investigate their implications for the design of trade policies. The focus of the report is the European Union. MNEs account for a significant share of economic activities in Europe. 18 % of EU employees in manufacturing work in foreign owned subsidiaries and 8.6 % in subsidiaries owned by non-EU residents. The report also devotes particular attention to the activities of US subsidiaries in Europe and of EU subsidiaries in the US, the only ones for which comprehensive data are available.
 
The empirical analysis in the report reveals a positive correlation between sectors with relatively high protection and a high presence of US FDI. This indicates that a substantial proportion of any rents created by restrictive trade policy is transferred to foreign firms. European trade policy is protecting those industries where subsidiaries’ sales dominate over imports from the US and where the US subsidiaries’ share in EU employment is large. The phenomenal increase of European networking in the CEECs following the Europe Agreements or between the US and Mexico after the implementation of NAFTA are good examples of how trade liberalisation, proximity and differences in factor costs jointly provide strong incentives for firms to split geographically their production processes.
 
There are some strong arguments in favour of international co-ordination of foreign investment policies. A new investment agreement could take care of this need for co-ordination; however, extending existing trade agreements could also do at least part of the job.

Report prepared for the European Commission Directorate General for Trade, March 8, 2002

March 18, 2002.