Market Failures and MNEs

Anticipating complex contractual issues, which can lead to market 'failures', managers often choose to bring economic activity inside the firm. (We are, of course, using 'failure' in a comparative institutional context, reflecting an understanding that better ways of organizing are possible.) Such internalization, in turn, implies foreign direct investment (FDI) in partially or wholly owned subsidiary companies. There are at least three types of market failures that relate to the existence and structure of multinational enterprises (MNEs). The first occurs when transaction costs are high relative to the administrative costs of organizing an activity internally. A second type of market failure concerns the relative inefficiency of markets for the transfer of certain types of resources, such as knowledge and capabilities. In a third case, markets do not exist at all until individuals exercise entrepreneurship and deploy resources to create or co-create them.