Follow FDI: Production Networks and the Geography of Globalization

The follow FDI phenomenon and its effects on changing supply chains

Follow FDI describes the phenomenon whereby, when a multinational firm establishes a foreign subsidiary, its domestic suppliers tend to follow and set up operations in the same location, effectively replicating the domestic supply chain structure in a foreign market. Anecdotal examples abound. During Toyota’s expansion into Thailand in the 1990s, its production was supported exclusively by Japanese parts suppliers, with Toyota Thailand reportedly not relying on any non-Japanese suppliers for critical components in the late 1990s. This is a remarkable degree of supply chain insularity for a firm operating thousands of miles from its home base. Similarly, Mazda’s entry into Mexico attracted Japanese component manufacturers such as Ashimori Industry, a producer of airbags and seatbelts that followed Mazda and other Japanese automakers to establish a local affiliate. These case studies from the international business literature, as well as parallels observed in European car manufacturing expanding into Eastern Europe, point to a broader pattern that the research seeks to quantify and test systematically using large-scale firm-level data. A particularly striking data point motivates the inquiry: 20% of all sales by Japanese multinationals abroad go not to local customers or consumers in the host country, but to other Japanese multinationals operating in the same host country. This figure alone suggests that a substantial share of foreign direct investment is driven by supply chain replication rather than conventional market-seeking behavior. From a research perspective, this challenges standard models of horizontal FDI, which typically treat firms as independent actors whose investment decisions are shaped solely by their own productivity, size, or market access conditions. From a policy perspective, it raises important questions about the true nature of multinational activity and its benefits for host economies, as well as the extent to which FDI promotion policies may have broader multiplier effects across entire supplier networks than previously assumed.

Key facts from the data

The analysis draws on two datasets: the Basic Survey on Overseas Business Activities (BSOBA), which tracks Japanese affiliates abroad and their sales broken down by customer type, and the Tokyo Shoko Research database, which maps the full domestic firm-to-firm production network in Japan over a long time period. Crucially, the BSOBA data allows the authors to distinguish not only total affiliate sales, but also how much of those sales go to local firms, to other Japanese affiliates in the same country, and to other foreign entities. This is a level of granularity that is relatively unique to this Japanese dataset and central to measuring the follow FDI phenomenon directly. The second data set covers the domestic production network in Japan. Four stylized facts emerge from combining these two datasets. First, while only 0.6% of Japanese firms are multinationals, over 20% of all firms have multinational customers or suppliers, and the average multinational has around 70 to 90 domestic supply chain connections compared to just four for the average non-multinational firm, reflecting the outsized influence of multinationals on the broader Japanese economy. Second, multinational status is strongly correlated within production networks: firms whose customers or suppliers are multinationals are themselves significantly more likely to be multinationals, which is consistent with the follow FDI hypothesis. Third, and most strikingly, follow FDI is large in scale. On average, one-third of local affiliate sales go to other Japanese multinationals in the same host country, reaching as high as 60% in Thailand and also notably elevated in China, Vietnam, and the United States, while being much lower in countries like Australia, Germany, or Korea, suggesting that the phenomenon is shaped by the nature and history of Japanese investment in each location. Fourth, follow FDI firms tend to be smaller at home, with a clear negative relationship between firm size in Japan and the share of foreign sales directed at other Japanese affiliates abroad. This finding is consistent with the idea that smaller parts suppliers, lacking the scale and resources to enter foreign markets independently, depend heavily on their large multinational lead customers when first expanding internationally.

Causal evidence from event studies

To establish causality, the authors employ an event study approach, comparing firms that become first-time suppliers to a multinational between 2014 and 2022 against a control group of firms that never acquire a multinational customer over the same period. The underlying logic is straightforward: if follow FDI is a real mechanism, then a firm’s probability of becoming a multinational should increase precisely after it gains its first multinational customer, and not before. The results confirm this pattern clearly. The probability of a firm becoming a multinational is flat and centered around zero in the years prior to gaining a multinational customer, but rises steadily in each of the four years thereafter, increasing by 0.2 percentage points in total. This represents a 33% rise relative to the baseline multinational rate of 0.6%. While this may sound modest in absolute terms, it is economically meaningful given how rare multinational status is among Japanese firms. This effect is particularly pronounced among manufacturing firms, though it is also applicable more broadly across other industries. To address the concern that firms may simply be on an independent growth trajectory that simultaneously leads them to attract multinational customers and expand abroad, thereby implying that the results reflect firm quality rather than follow FDI, the analysis is refined to the firm-country level. This sharper test asks whether a supplier becomes more likely to invest specifically in the country where its customer already has a subsidiary, rather than simply becoming a multinational in general. By controlling for the overall propensity to become a multinational, this approach isolates the follow FDI channel more cleanly, and the results continue to strongly support the hypothesis. A further robustness check confirms that merely gaining a large (non-multinational) customer does not produce the same effect, demonstrating that multinational status is the key driver of the follow FDI pattern, rather than customer size alone.

A simple economic model and its predictions

The research on follow FDI has developed a theoretical framework to explain the mechanism of follow FDI and derive testable predictions that can be taken back to the data. Two core ingredients are required for the model to work: geographic proximity must matter in some form, whether through physical transportation costs, coordination needs, or the value of face-to-face interaction between buyers and suppliers, and inputs supplied by one firm cannot be perfectly substituted by alternatives available in the host country. The latter point touches on the nature of long-term supplier relationships in the Japanese automotive industry, where deeply embedded ties, quality standards, and product-specific customization make switching to local suppliers extremely difficult, at least in the short to medium run. Additionally, uncertainty also plays a role. A small parts producer considering whether to set up a factory in Mexico faces significant risks, but the knowledge that a major customer such as large Japanese automobile manufacturers are already there and likely to demand its products substantially reduces that uncertainty and lowers the effective barrier to entry. The model first takes the perspective of the lead firm, showing that it will demand more from a supplier located nearby in the host country than from one shipping goods from Japan, due to lower transportation and coordination costs. It then considers the supplier’s decision, deriving the conditions under which relocating abroad is more profitable than staying home. Three testable predictions follow. Follow FDI is more likely when the lead firm is large and thus represents a significant share of the supplier’s potential revenue abroad; when the lead firm is input-intensive, meaning it relies heavily on parts and components rather than local labor; and when trade or coordination costs are high, or conversely when the fixed costs of setting up a foreign subsidiary are relatively low. All three predictions are confirmed in the data, with event study results showing a clearly stronger follow FDI effect when customers are both large and operating in input-intensive industries, lending further credibility to the proposed mechanism.

Policy implications

The findings carry a range of implications for policymakers in both the source and the host country. From a source-country perspective, policies designed to encourage firms to become multinationals have broader multiplier effects than previously recognized, since a single firm’s decision to invest abroad is likely to trigger a wave of follow FDI among its domestic suppliers. From a host-country perspective, attracting a single lead firm, for instance through targeted FDI promotion, may generate a substantially larger inflow of investment and employment creation than the initial incentive would suggest, effectively lowering the cost per job created. However, because follow FDI firms tend to transact primarily with other Japanese affiliates rather than with local firms, the scope for positive knowledge and productivity spillovers to the domestic economy may be more limited than traditional FDI theory assumes, and this trade-off warrants further investigation. On the question of supply chain resilience, replicating a domestic supplier network within a single host country reduces exposure to cross-border tariff shocks and trade policy uncertainty. This is a consideration that has become increasingly relevant in the current environment of geopolitical tension and recurring trade disputes. At the same time, if lead firms were to reshore production back to Japan, the effects observed in relation with follow FDI would amplify the resulting contraction in outward investment. One important nuance, however, is that follower firms may over time develop independent customer networks in host countries, making them less likely to take the reverse course back to their source countries even if their original lead customer withdraws.

Comment

SAITO Yukiko:
The research on follow FDI documents new evidence that a large share of transactions in host countries occurs among Japanese affiliates, that smaller firms, such as car parts suppliers, tend to follow lead firms abroad at lower fixed entry costs by leveraging the guaranteed customer relationship, and that supplying to multinationals significantly increases the probability of undertaking FDI. The theoretical model’s core predictions that follow behavior is stronger when customers are multinational and input-intensive, and that higher trade or coordination costs make following more likely are well supported empirically. A clear contribution to the literature lies in demonstrating that firms’ decisions are interdependent rather than made in isolation, challenging standard models in which firms are treated as independent agents, and that the share of so-called horizontal FDI has likely been overestimated, since a significant portion of local sales are in fact directed at other Japanese affiliates rather than the host-country market.

Several policy implications warrant further discussion. For host countries, follow FDI generates broader employment effects as both lead firms and followers create jobs, but may simultaneously reduce spillovers to the domestic economy, since affiliates transact primarily among themselves rather than with local firms, thereby limiting the technology transfer and productivity gains that are typically associated with inward FDI. For Japan, a substitution effect on domestic employment is possible as production shifts abroad, though demand-side effects stemming from expanded multinational activity may offset this, with potentially different outcomes for large lead firms and smaller followers. The relevance of short- vs. long-term dynamics also deserves attention, as lead firms such as Toyota have been observed gradually integrating local suppliers in host countries over time, which may alter the structure of follow FDI networks as they mature. Additional questions concern the implications of geopolitical shocks or natural disasters for mirrored production networks, whether the replication of supply chains abroad influences the ability of firms to disengage from a host country such as China, and what policy levers in terms of both efficiency and resilience may be appropriate in light of these mechanisms.

Andreas MOXNES:
On supply chain resilience, concentrating a supply network within a single host country, such as Vietnam, Thailand, or Mexico, reduces exposure to cross-border tariffs and international trade shocks, suggesting that follow FDI may in fact strengthen resilience in the current environment of heightened policy uncertainty and recurring trade disputes. Rather than stretching supply chains across multiple jurisdictions, follow FDI effectively recreates the domestic supply network within a single foreign market, thereby limiting the number of borders that goods must cross and minimizing tariff exposure. For host countries, follow FDI creates a multiplier effect on FDI inflows and employment, as attracting one lead firm can bring a cascade of additional suppliers in its wake, potentially raising the return on government expenditure resulting from FDI promotion. However, the spillover benefits to the local economy may be more limited than conventional FDI theory would suggest, since affiliates trade predominantly with one another rather than sourcing from or selling to domestic firms. Whether the positive employment effect outweighs the reduced spillover channel is an open empirical question that would require a dedicated research project to resolve. On employment in Japan, while follow FDI may mechanically shift more activity abroad as both lead firms and their supplier networks relocate, the broader research literature generally finds complementarity rather than substitution between outward FDI and parent-country employment, suggesting that the net effect on Japan is not necessarily negative. However, outcomes may differ meaningfully by firm type, industry, and the degree to which foreign and domestic operations serve as substitutes or complements.

Q&A

Q:
Follow FDI appears to be particularly strong among Japanese multinationals, arguably due to the comparative advantage of Japanese suppliers in producing highly specialized parts and components. Does this specific characteristic of Japanese industrial organization limit the external validity of the findings, or can the results be considered relevant for multinationals from other countries as well?

Andreas Moxnes:
While follow FDI may be more pronounced in the Japanese context, the phenomenon is not unique to Japan. Case studies from the international business literature document the same pattern in Eastern Europe: when European car manufacturers such as BMW established factories in Hungary following the EU’s eastward expansion, their suppliers relocated there as well. The Japanese car industry may represent a particularly clear-cut case given the depth and specialization of its domestic supply networks, but the underlying mechanisms, such as geographic proximity, input non-substitutability, and uncertainty reduction, are general enough to apply across countries and industries. Follow FDI is therefore a broader phenomenon, and while our research focused on Japanese industry, finding high intensity in follow FDI, the phenomenon may in fact be more common that previously expected, but further examination is necessary.

Q:
The analysis compared manufacturing firms with all firms combined, and results appear to be stronger in manufacturing. However, given that physical transportation costs are less central outside of goods production, what can be observed regarding follow FDI in the service sector, and what mechanisms might drive it there?

Andreas Moxnes:
Although physical transportation costs, which are a primary driver in manufacturing where shipping components across borders is both costly and logistically complex, are less relevant for the service industry, other frictions such as coordination costs and the value of face-to-face interaction remain significant across sectors. The need to maintain close contact with customers and suppliers, to coordinate operations, and to build trust through direct engagement applies just as much to service firms as to parts manufacturers. Analysis of follow FDI shares across all industries in the Japanese data confirms that the phenomenon extends well beyond manufacturing and is present in services as well, suggesting that proximity-related costs take different forms but remain relevant regardless of sector.

Q:
Given the current interest in reshoring and friend-shoring as responses to geopolitical risk and supply chain vulnerabilities, what are the broader implications of follow FDI for the potential reorganization of global supply chains back toward Japan or toward countries with which Japan maintains friendly economic relations?

Andreas Moxnes:
Follow FDI amplifies investment flows in both directions: just as outward FDI attracts supplier followers, a reversal toward reshoring would be similarly magnified, with suppliers potentially unwinding their foreign presence alongside the lead firm. However, an important qualification is that suppliers who initially went abroad to serve a Japanese lead customer may over time develop broader networks of both Japanese and non-Japanese customers in the host country. A car parts supplier that first relocated to Thailand or Mexico to serve a single Japanese automaker may, after several years, have established relationships with local firms and other foreign firms. When such networks are in place, suppliers may choose to remain in the host country even if the lead firm decides to reshore its facilities. The follow FDI share may therefore be highest in the early years of a supplier’s foreign presence and decline as the firm gains greater independence. This is a dynamic that warrants further investigation.