The MNE's rationale, according to the transaction-cost model, lies in the administered international deployment of its proprietary assets so as to evade the failures of arm's-length markets. Premier among those assets is the knowledge embodied in new products, processes, proprietary technology, and business organization. Therefore, the multinational enterprise (MNE) plays a role in the production and dissemination of new productive knowledge that is central if not exclusive. Although arm's-length markets for technology are failure prone, they do exist. Many companies that produce new knowledge are not multinational, and many proprietary intangibles are sold or rented between unrelated parties, or simply copied. The determinants of the trade-off between arm's-length transfers and transfers within MNEs are emphasized because of its role in the necessary conditions for MNEs' operation (Chapter 1).

This chapter starts with empirical evidence on how the MNE makes its decisions about producing and disseminating technology. It proceeds to a treatment of the consequences of this activity for economic change and economic policy. The policy issues are particularly urgent in this case. Not only does the market for knowledge bristle with potential failings but also international trade in technical knowledge runs into the familiar conflict between the interests of source and host countries.

The MNE as Producer of Technical Knowledge

Research on the production and distribution of industrial knowledge customarily distinguishes three phases of the process. Invention covers the generation of a new idea and its development to the point where the inventor can show that “it works.”