By Alan M. Rugman (auth.)
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It overcomes the externality by internalization. If there were perfect goods or factor markets in the first place then there would be no reason for an MNE to develop and free trade would exist. In this theoretical situation Internalization and Foreign Direct Investment 21 we have free trade being determined by country specific factors or a world of market imperfections in which the MNE operates due to firm specific factors. In practice there are elements of both country specific and firm specific factors in existence, so the MNE is more important when there are relatively greater restrictions on free trade than when such barriers are assumed away, as in the Heckscher-Ohlin world.
Although not stated explicitly, his model treats K as an intermediate product which is internalized in the structure of the MNE. Hirsch unfortunately does not consider explicitly the conditions for licensing, the third possible method of servicing a 26 Inside the Multinationals foreign market, along with exporting or FDI. This third option, of licensing, is viable at the end of the firm's technology cycle rather than at an early stage of foreign activity as is sometimes argued in the literature on international business.
The unique advantage of the resulting international diversification is that it permits the nondiversifiable (or 'systematic risk') of anyone stock market, or economy, to be reduced by holding an international portfolio of assets. This unique gain (demonstrated in several recent academic studies) of international diversification is not available from industrial diversification within anyone economy. The potential gains are especially important for investors in small open economies. Multinationals and the New Theory of Internalization 15 Yet, to the extent that recent developments in the international monetary system have created barriers to the free movement of capital between nations these potential gains are often denied individual investors.