Theories of international production

In this chapter I am going to explain the theory of multinational and theory of why firms produce overseas.

Basically a multinational is an enterprise that engages in FDI and owns or controls value adding activities in more than one country (Dunning 1992)

Reasons for the creation of multinational enterprises:

1.      Classical/Neo Classical models of Trade

2.      Hymer’s Theory of International Production

3.      Vernon’s Product Life Cycle

4.      The Eclectic Paradigm

5.      Technological Accumulation Theory

6.      The Investment Development Path

7.      Alliance Capitalism

The Traditional (classical or neo-classical) models of trade

1.      It was the dominant paradigms until the 50's.

2.      It was the location aspect. That is they were considering the 'where' to produce.

3.      The firm will locate where the resources are the cheapest.

4.      Market is perfect.

5.      Entrepreneurs were assumed to be profit maximisers.

Focus on location aspect.

Hymer’s Theory of International Production

1.      First author to explain imperfect market.

2.      Hymer's greatest insight was on focusing attention upon the MNE as an institution for international production rather than international exchange.

3.      He asserted that FDI involved the transfer of a package of resources (technology, management skill, finance capital, ect).

4.      He further stipulated that for firms to own and control foreign value adding activities, they must possess some kind of innovatory, cost, financial or marketing advantages specific to their ownership which is sufficient enough to outweigh the disadvantages they face when competing with indigenous firms.

5.      Unfortunately, Hymer failed to distinguish between structural and transaction costs market imperfections. His entire analysis was based upon structural imperfections,

6.     Focus on ownership aspect.

The product life cycle

At a later stage, the product is exported5 to nations most similar to the US in demand patterns and standard of living. As the product matures and demand become more price-elastic, cost considerations become very important. The firm may relocalise its production facilities to lower cost producing countries.

However, the PLC theory did not stand the test of time. One of the main reasons for the demise of the PLC is that the technological leadership enjoyed by the US in the 50’s and early 60’s gave way to a more balanced technological competition between the US, Europe and Japan. Also, the US was no longer considered to be the highest income earners. Another reason is that investment in other countries was only of an import substituting nature6, but nowadays, leading MNEs have well-developed global networks.

Focus on location aspect

Technological Accumulation Theory (Kogut)

1.      For a firm to be able to go overseas and to be able to substance such an international presence; the firm have to continually update, innovate and upgrade its technology.

2.      The authors further argued that it was their ability to continually improve and refine their technology which permits the multinationals to retain its competitive edge.

3.      Kogut focus was on the ownership aspect.

The Investment Development path

Dunning’s (1981, 1986, 1988a) investment-development cycle was based on the proposition that the level of inward and outward foreign direct investment of different countries would depend upon their national stage of industrialisation.

            A country's ability to attract FDI - Inward FDI

            Export FDI - Outward FDI

It is directly related to the degree or level of industrialisation. Firm will locate depending on the level of industrialisation.

Focus on location aspect

Eclectic paradigm (article: reappraising the eclectic paradigm)

1.      Also known as the OLI (ownership leadership internalisation)  configuration.

2.      Not a theory. A framework which provide a synthesis of the different theories. (Gather all good advantages and minimises all disadvantages.)

3.      Dunning said: For international production to take place, 3 pre-condition have to be met:

                               I.            The firm have to possess an ownership advantage.
Exploit ownership advantage.
Create a subsidy.

                            II.            Firm has to choose an appropriate location based on location advantages.
(location advantages are advantages which are present/available in the host country, but are not present in the multinational's home country. Eample of location advantage: cheap labour, tax holidays, skilled labour, low political risks, flexible labour laws, steamline administrative advantages).

Alliance capitalisation/ asset creating theory

With globalisation and the resulting increase in competition in given shorter product life cycle, firms are increasingly having to invest in research and development (R & D); something that they will find it increasingly difficult to sustain. As a result, firms are increasingly entering into collaborative arrangement or strategic alliances by merging their core competencies(ownership advantage) in the hope that this would create a new core competency which should allow both firms to remain competitive.

Alliance capitalisation is also synonymous production from a network of location, which is the opposite of fordism (production from single location, i.e production of standardise model).

Alliance capitalisation is a complete theory because it talks of ownership, location and internalisation.

Theories of international production may be analyse by 3 levels, micro-level, macro-level and meso-level. Discuss.

Microeconomic level	Macroeconomic level	Mesoeconomic level
Hymer’s Theory of International Production	Classical/Neo Classical models of Trade	Alliance Capitalism
Alliance Capitalism	Vernon’s Product Life Cycle
	The Investment Development Path
	Alliance Capitalism

Summary

·         A Multinational Enterprise is an enterprise that engages in foreign direct investment (FDI) and owns and controls value-adding activities in more than country (Dunning, 1992). 

·         It may be argued that the neo classical/ classical models of trade addressed only the ‘where’ to produce issue and ignored questions related to the ownership and organization of activity. In addition, the underlying assumption of a perfect market does not hold true in practice and once market imperfections were introduced, the pattern of ownership and the modality of organising transactions changed.

·         Hymer’s greatest insight was on focusing attention upon the MNE as an institution for international production rather than international exchange. He asserted that FDI involved the transfer of a package of resources (technology, management skill, finance capital, etc) and not just finance capital which portfolio theorists such as Iversen (1935) had sought to explain.

·         Raymond Vernon (1966) used a micro-economic concept, the product life cycle, to help explain a macro-economic phenomenon, namely the tremendous post-war expansion of trade and investment in the manufacturing industry between the US and Europe.

• Kogut, among others, argued that it was their ability to continually improve and refine their technology which permits the multinationals to retain its competitive edge.

·         In order to exploit effectively and speedily their core competencies, firms are increasingly finding that they need to combine their competencies with those of other firms. This has led to the proliferation of what is known as “alliance capitalism”.