Now, let's consider some of the basics
of the economics of multinational corporations.
A multinational enterprise, or MNE for short,
occurs when a company based in one country sets up factories or maybe retail outlets
in other countries to better sell its product.
Multinationals are truly a significant force in foreign trade.
To give one example, about 3/4 of U.S. exports
actually are run through the foreign affiliates of multinationals.
The source there is this article on multinationals,
which is also a very good introduction to the topic.
A closely related concept to multinationals is foreign direct investments or FDI.
So, imagine that Ford Motor Company of the United States
builds an automobile plant in Germany, or in Brazil, or in Mexico.
Those are examples of FDI.
A lot of the popular commentary on multinationals
treats them as some kind of sinister force or conspiracy
out to take over the world or impoverish global citizens.
Multinationals face the dual strike of
both being large corporations and being foreign,
two things which people sometimes are afraid of.
The general truth about multiantionals is actually far more prosaic.
On average, they tend to raise wages,
to raise productivity in the countries they operate in,
and also to spread useful products around the world.
We'll be returning to some of those themes in other videos.
Any attempt to explain multinationals has to confront the question:
Compared to what?
One alternative or substitute is,
rather than owning an investment overseas,
to license the relevant technology to a foreign company.
Another alternative is simply to produce more in the factory in the home country
and then export more rather than building a separate factory abroad.
If we consider licensing arrangements,
well, does it make more sense to license your technology to a foreign partner,
or to build a factory in another country yourself?
This is mainly a matter of transactions costs,
and this is fairly well covered by the theory of industrial organization.
In some cases, it's lower costs to try to manage the license,
and in other cases it's cheaper to actually build and run the factory yourself.
A more common comparison in this literature
is to compare the multinational to exporting more from the home country.
And in this case, the core theory postulates that there is a trade-off
between proximity and concentration advantages.
So, let's say, for instance, that there are increasing returns to scale,
to producing everything in a single plant in the home country.
That force would then tend to encourage a single, very large factory,
again in the home country, and a lot of exporting.
On the other side of the ledger is the countervailing factor of trade costs.
It costs something to produce everything in the home country
and then have to ship it around the entire world
and maybe also pay tariffs.
That will encourage the setting up of plants in foreign countries.
So the trade-off is this,
when increasing returns to scale and that single plant are high,
you tend to get a lot of exporting.
But when trade costs are high, you tend to get more multinationals.
You'll find these and some other factors outlined
in two very important papers by Lael Brainard,
one of the leading researchers in this area.
There is also an important distinction between
horizontal foreign direct investment and vertical direct investment.
For instance, it's an example of horizontal direct investment
when Ford Motor Company is setting up that plant in Mexico or Germany.
Think of this as horizontal because they are setting up
a Mexican or German version
of something they've already been doing in the United States.
An example of vertical FDI is something like the iPhone.
The iPhone is produced with components made in Taiwan,
the Philippines, and other places,
and then the final assembly happens in China.
It's a new and indeed fragmented production process,
and it's not simply trying to copy some kind of factory already operating
in the United States or whatever the home country might happen to be.
You tend to get vertical multinationals
when there are underpriced factors distributed across other countries.
For instance, for a long time,
it's been the case that labor in China has been underpriced,
relative to how much it can produce
unless you've had a lot of foreign direct investment going into China,
including to produce iPhones.
In general, for vertical multinationals,
you tend to get the R&D happening where skilled labor is cheap,
and you tend to get the actual production happening where less skilled labor is cheap.
So imagine, say, designing an iPhone in Silicone Valley
and then doing the final assembly in China.
The recent trend has been that vertical multinationals
are growing considerably faster than horizontal multinationals,
and that also means that there has been more foreign direct investment
flowing to poorer countries.
If you look at some of the older literature,
you'll find claims that most multinationals take the horizontal form,
and indeed, that was true at that time, but this has been changing.
On all of these matters, there is a very good paper by Alfaro and Charlton.
An example here would be the multinational Foxconn, based in Taiwan.
It produces the Wii, the Kindle, and the PlayStation,
very often with final assembly in China.
For other sources on multinationals,
these two articles listed here are very good places to start,
they are available online.
And for yet further useful sources, including some surveys,
I would recommend these articles listed here,
again, available online.