DISCUSSION PAPERS IN ECONOMICS

The goods that are consumed in developed countries are increasingly manufactured in developing countries. A developing-country producer can work with a local headquarter (withinborder partnership); alternatively, it can form a cross-border partnership with a headquarter in developed countries. This paper develops a theory where the choice between cross-border partnership and within-border partnership depends on the size of the gain through technology transfer from developed-country headquarters. When developing-country producers have heterogeneous productivity, those with medium levels of productivity will gain su¢ ciently from technology transfer and choose cross-border partnership. In contrast, highand lowproductivity producers will work with their local headquarters, and the low-productivity producers will not be able to sell their products to developed countries at all. This paper also shows that among the producers that engage in cross-border partnership, those with relatively high productivity become vertically integrated with their developed-country headquarters, while those with relatively low productivity operate at arm’s length. These predictions are supported by …rm-level evidence from China.