Theories Of Multinational Enterprises. Why Do They Exist?

1504 words - 6 pages

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 licensing, the attractiveness of exporting decreases.For example the differential rate of return hypothesis suggests FDI is undertaken to take advantage of higher rates of return in foreign locations; this hypothesis assumes that the goal of firms is to maximise profits;Portfolio hypothesis considers both the rate of return and a risk element, arguing that FDI is positively associated with the rate of return and negatively related to risk;1. An example of a market imperfection in the goods market that serves as a barrier to free trade is tariffs. A country that erects barriers to trade to protect a domestic industry will simply attract subsidiaries of an MNE, who can avoid customs duties by undertaking production in the host nation2. Similarly the largely neo-classical flexible accelerator model of investment has also been extended to foreign capital movementsImperfections in the markets for intermediate goods always lead to the development of MNE's. For example, imperfections exist in the markets for knowledge, information, technology, marketing and managerial expertise. A firm possessing an advantage in any of these areas is able to close markets (reduce competition) and increase its market power.With regard to horizontal FDI, market imperfections arise in two circumstances:- when there are impediments to the free flow of products between nations decrease the profitability of exporting, relative to FDI and licensing- when there are impediments to the sale of know-how (Licensing is a mechanism for selling know-how.) increase the profitability of FDI relative to licensingFDI will be preferred whenever there are impediments that make both exporting and the sale of know-how difficult and/or expensive.All of this suggests that when one or more of the following conditions holds, markets fail as a mechanism for selling know-how and FDI is more profitable than licensing:(1) When the firm has valuable know-how that cannot be adequately protected by a licensing contract,(2) When the firm needs tight control over a foreign entity to maximize its market share and earnings in that country,(3) When a firm's skills and know-how are not amenable to licensing.Multipoint competition arises when two or more enterprises encounter each...

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