Firm Productivity and Foreign Direct Investment into Non-core Activities* Andrzej Cies ´lik and Michael Ryan Received 8 February 2008; Accepted 9 April 2009 As foreign direct investment (FDI) often originates from multinational enterprises (MNEs) with non-core activities and not single-product firms, as MNE theory typically suggests, we hypothesize that such firms are more productive than MNEs without non-core activities as well as non-MNE firms. We test this hypothesis using Kolmogorov–Smirnov stochastic dominanceTests and Japanese firm-level produc- tivity and FDI data for the period 1985–2001. We find that both manufacturing and service multinational firms with non-core foreign investments stochastically domi- nate firms without non-core activities. We also find cost-complementarities between certain core and non-core FDI activities that span both manufacturing and service affiliates. Keywords: firm productivity, non-core activities, Japanese direct investment. JEL classification code: F23. doi: 10.1111/j.1467-8381.2009.02013.x I. Introduction The past few decades have seen multinational enterprises (MNEs) become the major players in the globalization of national economies. In fact, in the 1980s and the 1990s foreign direct investment (FDI) by these firms grew at faster rates than both international trade and GDP. This remarkable trend in the internationaliza- tion of economic activity led to the development of the new theory of multina- tional enterprise that has been recently merged with the firm heterogeneity literature. However, despite the considerable amount of theoretical work, substan- tial difficulties still exist in explaining actual trade and investment patterns. In particular, three of the major stylized facts that characterize the modern world economy are left unexamined: (i) FDI traditionally occurs by MNEs invest- ing in both core and non-core activities; (ii) an increasing share of global FDI flows go into service sectors, with these investments originating from both service firms and manufacturing firms (for which services are non-core activities); 1 and * Cies ´lik: Macroeconomics and International Trade Theory Division, Department of Economics, Warsaw University ul. Dluga 44/50, Warszawa PL-00241, Poland. Email: cieslik@wne.uw.edu.pl. Ryan (corresponding author): Department of Economics, Western Michigan University, 1903 W. Michigan Ave., Kalamazoo, MI 49008, USA. Email: michael.ryan@wmich.edu 1. Note that in the Toyo Keizai data used in the present study, approximately 80 percent of the count of new affiliates established by Japanese manufacturing firms in Europe during the 1990s was in Asian Economic Journal 2009,Vol. 23 No. 3, 297–321 297 © 2009 The Authors Journal compilation © 2009 East Asian Economic Association and Blackwell Publishing Ltd.