Question

Is the theory of multinational enterprise essentially consistent or inconsistent with the traditional model of comparative advantage?

Short answer

The theory of multinational enterprise is not essentially consistent with the traditional model of comparative advantage as they approach from different angles, but neither is it entirely inconsistent. Both theories recognize the benefits of international interaction, but apply to different levels of the economy - micro and macro.

Step-by-step solution

Understand the Theory of Multinational Enterprise

The theory of multinational enterprise posits that companies spread across national boundaries not merely for simple market access, but also in order to gain specific competitive advantages related to economies of scale, owing to operating in multiple countries, and internalizing cross-border markets. They establish subsidiaries in other countries to exploit the assets that are proprietary to the firm.

Understand the Model of Comparative Advantage

The traditional model of comparative advantage suggests that every country should specialize in the production of goods and services that it can produce more efficiently than others. By doing so, it can trade for goods that it produces less efficiently, resulting in more economic efficiency and higher global output.

Consider the Consistency

Assess whether the theory of multinational enterprises aligns or contradicts with the traditional model of comparative advantage. While both theories advocate for trade and argue that these can increase efficiency, they approach from different angles. The theory of multinational enterprises does not necessarily align with the traditional model of comparative advantage because it focuses more on firm-specific advantages, while comparative advantage emphasizes on country-specific efficiency. However, it does not entirely contradict it, as both theories recognize the benefit of engaging in foreign markets to optimize output and efficiency.

Key concepts

Comparative Advantage

The concept of comparative advantage is a fundamental principle in economics. It suggests that countries should specialize in producing those goods and services that they can create more efficiently than others. By following this principle, countries can trade for goods they produce less efficiently, optimizing both economic efficiency and global output.
Imagine a world where each country focuses on its strengths. For instance, if Country A can produce cars at a lower opportunity cost than textiles, it should focus on manufacturing cars and trade with Country B, which might be more specialized in textiles. This tradeoff allows each country to benefit from higher efficiency than if they tried to produce both products on their own.
This principle underlies much of the global trade system today and highlights the idea that everyone can benefit from trade. International trade allows countries to leverage their unique capabilities, fostering economic growth and improved standards of living worldwide.

Economies of Scale

Economies of scale refer to the cost advantages that enterprises obtain due to their scale of operation, with cost per unit of output generally decreasing with increasing scale as fixed costs are spread out over more units of output.
When a company operates on a large scale, it can reduce costs and increase production efficiency. For example, a multinational enterprise can purchase raw materials in bulk at discounted rates, negotiate better contracts, and utilize technology more effectively across its global operations.
Moreover, these savings allow firms to reinvest in innovation and competitive pricing, positioning themselves more robustly against competitors. By expanding their operations internationally, firms can exploit these economies of scale further, accessing broader customer bases and diversifying their market reach.

Cross-Border Markets

Cross-border markets describe the flow of goods, services, and capital across country boundaries. These markets are crucial for multinational enterprises that look to leverage international opportunities for growth.
Multinational companies often establish subsidiaries in foreign countries to tap into local markets and capitalize on regional expertise. This strategy allows them to understand customer preferences more deeply and adapt products to meet the specific needs of different cultures and regulations.
Furthermore, cross-border markets present opportunities for firms to optimize their supply chains by locating different stages of production where they are most efficient. By doing this, businesses maintain competitive advantages while contributing to local economies, creating a globally interdependent economic landscape.