A Model of Global Firms and Capital Markets

Abstract

We develop a general-equilibrium model of the global economy that integrates heterogeneous firms competing in product markets with countries that allocate capital around the world. Combining a hedonic demand system on the product side with a mean-variance portfolio system on the asset side, we obtain almost closed-form solutions for the equilibrium of the model. We use firm-level data on balance sheets, geographic breakdowns of revenue and employment, and business descriptions along with country-level data on bilateral equity holdings and trade costs to quantify the model to a cross section of roughly 23,000 listed firms in 48 countries. We use the model to evaluate the reallocation and welfare effects of globalization. Both financial and trade liberalization concentrate activity among the largest firms and raise welfare, with gains being larger in emerging and mid-sized open economies respectively. Product- and capital-market frictions amplify each other, meaning that liberalizing one market reduces the gains from liberalizing the other.