Multinational firms, technology diffusion and trade

Attempts to add multinational firms to the 'new' trade theories generate predictions about direct investment dramatically at odds with the facts. A failure to treat internalization adequately seems responsible at least in part. Empirical evidence also indicates a close association between multinational firms and knowledge capital; we exploit this to examine the role of internalization and its relation to locational factors. We model a firm which must choose between costly exporting and the possible dissipation of its knowledge capital by producing abroad. The paper examines the choice between exporting, licensing, and acquiring a subsidiary in this environment. We analyze the cost and technology parameters that support alternative modes of serving the foreign market, and we describe the international equilibrium that jointly determines the pattern of specialization and the market mode. We find that similarities in relative factor endowments may promote direct investment.