Theories of Multinational Enterprises. Why do they exist?

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Assuming perfect markets and free trade, then exporting would be the most efficient method of serving foreign markets and FDI would not take place. In this framework there is no need for the MNE. International production must therefore be a response to some market imperfections in the goods or factor markets. Trade, the result of country-specific advantages, is replaced by firm-specific advantages, which lead to FDI. When transportation costs are added to production costs, it becomes unprofitable to ship some products over a large distance. This is particularly true of products that have a low value-to-weight ratio and can be produced in almost any location (e.g., cement, soft drinks, etc.). For such products, relative to either FDI or…show more content…
Internalization - for certain types of transactions, the market is inefficient and costly. The costs involved in undertaking transactions through the market include the cost of finding relevant prices, costs involved in drawing up contracts, and costs associated with risk attached to any contract. If a firm can organise and undertake transactions more efficiently within the firm rather than through the market, then the firm internalises these transactions. Internalisation can occur in response to any type of market imperfection or externality in the goods or factor market. Imperfections in the goods market, such as barriers to trade, will induce the firm to undertake FDI rather than trade. Similarly, imperfections in the factor markets, such as the market for knowledge and information, will generate the MNE through the process of internalisation. FDI will occur when the advantages in the firm's possession outweigh the additional costs. The MNE will prefer to undertake foreign production through a subsidiary as it is able to keep its advantage within the firm, and therefore recoup its costs and take full advantage of its monopoly. Production through a licensing arrangement or joint venture would increase the likelihood of rival firms accessing its advantage. The MNE exists, therefore, as it is able to internalise the market for intermediate goods and factor inputs in response to
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