Risky Business: Multinationals, Uncertainty and Asymmetric Insurance

Abstract

A partial equilibrium model is used to examine the international production allocation of a two-plant multinational firm that is confronted with uncertainty with respect to foreign sales. The firm produces identical products in both plants, using firm-specific factors. The internationally price-discriminating multinational has monopoly power in both segmented markets. The analysis focuses on how asymmetric insurance facilities between the firm's home and host country influence its international production allocation and level of intra-firm trade.

Risk in international business and its mitigation

“…Asymmetries in the availability of insurance schemes, therefore, expose MNEs to both moral hazard and adverse selection problems(Dewit, 2002). Such impediments have macro level consequences on foreign investment levels.…”

“…For instance, by forcing the MNEs foreign plant to purchase a certain fraction of its inputs in the host country, the MNE, not only forgoes potentially some imported inputs but also exposes itself to the price variability of local inputs. The combination of risk mitigating government services at home and risk exacerbating polices abroad may, therefore, severely distort even curtail FDI in weak economies, despite the enormous investment potential in those markets(Dewit, 2002;Ullah, Wang, Stokes, & Xiao, 2019). Moreover, all business risks are at the expense of private consumption, present or future, and this is true whether risk are immediately shiftable to consumers in higher prices or whether they temporarily remain with producers, thereby reducing their income.…”

Multi-output firm under price uncertainty

“…Governments, for example, often underwrite entry into export markets, as modeled in Dewit (2002). They also seek to promote trade by stabilizing bilateral exchange rates.…”

Exporting against Risk? Theory and Evidence from Public Export Insurance Schemes in OECD Countries

“…Other papers include Abraham and Dewit (2000), who conclude for the case of the Belgian export insurance scheme, that subsidised insurance tends to be offered primarily to firms trading with former colonies. Finally, Dewit (2002) suggests that public export insurance schemes distort the incentive of multinational firms to invest in local plant capacity in favour of shipping commodities to foreign markets.…”