Beginning in the early 1980s, theoretical analyses have incorporated the multinational
firm into the microeconomic, general-equilibrium theory of international trade. Recent
advances indicate how vertical and horizontal multinationals arise endogenously as
determined by country characteristics, including relative size and relative endowment
differences, and trade and investment costs. Results also characterize the relationship
between foreign affiliate production and international trade in goods and services.
In this paper, we survey some of this recent work, and note the testable predictions
generated in the theory. In the second part of the paper, we examine empirical results
that relate foreign affiliate production to country characteristics and trade/investment
cost factors. We also review findings from analyses of the pattern of substitutability
or complementarity between trade and foreign production.