A multinational enterprise (MNE) is a firm that owns and controls operations in more than one country. Multinationals usually send a bundle of financial capital and intangible assets like technology, managerial capabilities, and marketing skills to their foreign affiliates. Foreign direct investment (FDI) is any flow of lending to, or purchase of ownership in, a foreign firm that is largely owned by residents of the investing, or home, country.

FDI grew rapidly for several decades after World War II, with the United States being the largest source country. FDI grew more slowly from the mid-1970s to the mid-1980s, but since the mid-1980s, FDI has grown rapidly. From the mid-1970s to the early 1990s, direct investment flows into developing countries slowed, but these flows have recently increased substantially. Nonetheless, most direct investment is from one industrialized country into another industrialized country. In the 1980s, the United States became an important host country, leaving Japan as the only major home country that is not also a major host to direct investment.

Explaining why multinational enterprises exist requires us to go beyond a simple competitive model. Multinationals can overcome the inherent disadvantages of being foreign by using their firm-specific advantages. Still, there are at least two alternatives to direct investment. The firm could export from its home country, but location factors often favor foreign production. The firms could rent or sell their advantages to foreign firms using licenses. Multinationals see internalization advantages to full control of the foreign use of their firm-specific advantages, especially their intangible assets like proprietary technology, marketing capabilities, brand names, and management practices. Negotiating licenses with independent foreign firms for them to use these assets would be costly and risky. Large multinationals are often involved in oligopolistic competition among themselves. For instance, one multinational attempts to gain an advantage by entering a foreign country first, and the others follow quickly to try to neutralize any advantage to the first firm.

The profits of foreign affiliates are taxed by the host-country government, but generally not taxed or taxed little by the home-country government. When multinationals shop around the globe for the lowest-cost sites, they favor low tax rates. Part of deciding of which country to invest in involves the desire to keep taxes down. In addition, firms can use transfer pricing to shift some reported profits to low-tax countries.

FDI could lead to less international trade in products (substitute for trade) or to more (complement to trade). FDI used to locate different stages of production in different countries increases trade. FDI used to establish affiliate production of final goods for local sales substitutes for imports. But better marketing by the affiliate can also expand imports of other final goods produced by the multinational enterprise in other countries. And affiliate production of final goods often requires use of imported components and materials. Studies of FDI and trade conclude that they are somewhat complementary, on average.

The home (or investing) country gains from the basic market effects of FDI as long as the investors themselves count. If they do not count as part of the home country, so that we exclude their investment incomes from measures of the national gain, then the home country can lose from FDI. The home country may also have other reasons to restrict outward-bound FDI: the possibility that it loses external benefits that accompany FDI, and the possibility of foreign-policy distortion from lobbying by multinationals. The actual policies of the industrialized countries (the major home countries) toward outward FDI are approximately neutral.

The host country has less reason to restrict FDI than does the home country. It gains from the basic market effects of FDI, and it gains from positive external technological and training benefits. In the past three decades many developing countries have shifted from restricting FDI inflows to encouraging them. Political dangers remain, however, in the relationship between host-country governments and major multinational enterprises.

Free international migration of people, like free trade in products, is the policy most likely to maximize world income. Yet perfect freedom to migrate is politically unlikely. The main beneficiaries of such a liberal policy, the migrants themselves, have little political voice in any country. More vocal are groups that resent the departure of emigrants or, more often, the arrival of immigrants.

The labor-market analysis of migration flows shows who wins and who loses from extra migration, and by how much. The main winners and losers from migration are the ones intuition would suggest: the migrants, their new employers, and workers who stay in the sending country all gain; competing workers in the new country and employers in the old country lose. Yet the net effects on nations, defined as excluding the migrants themselves, may clash with intuition.

The sending country as a whole loses, both in the labor markets and in the negative effect on the government budget. However, if the emigrants make large enough remittances back to the country, the sending country can gain from emigration. A case can be made for a brain-drain tax that compensates the sending country for its public investments in the emigrants.

The receiving country is a net gainer according to the labor-market analysis. In addition, it has often been true that immigrants pay more to their new country in taxes than they receive in public services. However, the declining relative quality of immigrants to the United States suggests that the government-budget effect is not so positive as it once was, and may now be negative. Immigrants also cause externalities, both positive (new knowledge) and negative (congestion, social friction).

The reason for the U.S. drift toward immigrants being a net fiscal burden is that the relative education and skill levels of immigrants has declined, as U.S. admission policy has given preference to family relatives and refugees since the mid-1960s. A country can improve the net economic effects of immigration by skewing its admissions toward selecting young, educated, and skilled adults and away from less skilled persons. While this policy would improve the economic side of the immigration accounts, it may clash with other objectives such as reuniting families and providing humanitarian aid to refugees.