Explaining International Production (Routledge Revivals)

John H. Dunning

• Publisher: Routledge
• Year: 2014
• ISBN:
  9781317576167
• Edition: 1
• Topic: Betriebswirtschaft
• Subtopic: Internationale Wirtschaft

John Dunning's general theory of international production, first propounded in the late 1970's, has generated considerable debate. This work thoughtfully reassesses the paradigm, and extends the analysis to embrace issues of theoretical and empirical importance. In a collection of essays, the changing characteristics of international production are examined, and an interdisciplinary approach suggested for understanding the multinational enterprise in the world economy.

This book, first published in 1988, will be of value not only to economists and international business analysts, but to scholars in other fields, notably organizational, marketing and management specialists.

Chapter One

Trade, Location of Economic Activity and the Multinational Enterprise: A Search for an Eclectic Approach

AN HISTORICAL INTRODUCTION

The main task of this chapter is to discuss ways in which production financed by foreign direct investment (FDI), that is, undertaken by multinational enterprises (MNEs), has affected our thinking about the international allocation of resources and the exchange of goods and services between countries. The analysis takes as its starting point the growing convergence between the theories of international trade and production, and argues the case for an integrated approach to international economic involvement, based on the location-specific (or comparative) advantages of countries and the ownership-specific (or competitive) advantages of enterprises.¹ In pursuing this approach, the chapter sets out a systemic explanation of the foreign activities of enterprises in terms of their ability to internalize markets to their advantage.

We begin by looking at the received doctrine on international economic involvement. Until around 1950 this mainly consisted of a well-developed formal theory of international trade and a complementary but less well-developed theory of capital movements. As Chapter 4 will argue, with the notable exceptions of John Williams (1929)² and Bertil Ohlin (1933), international economists of the interwar years were less concerned with explanations of the composition of goods and factors actually traded across boundaries (and implicitly, at least, with the spatial distribution of economic activity) than with theorizing on what would occur if, in the real world, certain conditions were present. The Heckscher-Ohlin model, for example, asserted that, provided certain conditions were met, countries would specialize in the production of goods which required relatively large inputs of resources with which they were comparatively well endowed, and would export these in exchange for others which required relatively large inputs of factors with which they were comparatively poorly endowed. The conditions included that countries had two homogeneous inputs, labour and capital, both of which were locationally immobile (i.e. they were to be used where they were located); inputs were converted into outputs by the most efficient (and internationally identical) production functions; all enterprises were price-takers, operating under conditions of atomistic competition; there were no barriers to trade and no transaction costs; and international tastes were similar. Technology was assumed to be a free good and instantaneously mobile across national boundaries.

The Heckscher–Ohlin model has been criticized in the literature on various grounds, including the unreality or inapplicability of its assumptions. Here, we would underline some of the implications of three of these assumptions: factor immobility, the identity of production functions and atomistic competition. These are, first, that all markets operate efficiently; second, there are no external economies of production or marketing; and third, information is costless and there are no barriers to trade or competition. In such a situation, international trade is the only possible form of international involvement; production by one country’s enterprises for a foreign market must be undertaken within the exporting country; and all enterprises have equal access to location-specific endowments.

One of the deductions of the Heckscher-Ohlin theory is that trade will equalize factor prices. Replacing the assumption of factor immobility with that of the immobility of goods, it may be shown that movements of factors also respond to differential resource endowments. This was the conclusion of the early writings of Nurkse (1933), Ohlin (1933) and Iversen (1935), which explained international (portfolio) capital movements in terms of relative factor prices or differential interest rates. For many years trade and capital theory paralleled each other, it being accepted that, in practice, trade in goods was at least a partial substitute for trade in factors. Eventually, the two were formally integrated into the factor price equalization theorem by Samuelson (1948) and Mundell (1957).

In the late 1950s there was a striking shift of direction in the interests of international economists brought on, inter alia, by the tremendous postwar changes in the form and pattern of trade and capital exports. Building on the empirical work of MacDougall (1951) and Leontief (1953 and 1956), and taking advantage of much improved statistical data, the 1960s saw the first real attempts to explain trade patterns as they were, rather than as they might be; contemporaneously, the emergence of international production as a major form of non-trade involvement was demanding an explanation.

Over the past 25 years the positive theory of international economic involvement has ‘taken off’. For most of the period it has comprised two quite separate strands. The first concerned explanations of trade flows. Here, contributions were mainly centred on introducing more realism into the Heckscher–Samuelson–Ohlin doctrine. Basically, there were two main approaches. The first was that of the neofactor theories, which extended the two-factor Heckscher–Ohlin–Samuelson (HOS) model to embrace other location-specific endowments (notably natural resources) and differences in the quality in inputs, especially labour. The second group of theories was more path-breaking, as they cut at the heart of the HOS model by allowing for the possibility of differences in the production function of enterprises and of imperfect markets. These theories, which included the neotechnology and economies of scale models, were different in kind to the neofactor theories because they introduced new explanatory variables which focused not on the specific resource endowments of countries but on the exclusive possession of certain assets by enterprises. Sometimes, in addition to, but more often as a substitute for, orthodox theories, these new hypotheses of trade flows have been exposed to various degrees of testing. Yet as Hufbauer (1970) has shown, the predictive power of the neofactor and the neotechnology theories is scarcely better than that of the crude factor proportions theory. In his own words, ‘No one theory monopolises the explanation of manufacturing trade’.

The second strand of research in the 1960s centred on explaining the growth and composition of foreign direct investment, or of production financed by such investment. Early explanations based on international capital theory as set out by Iversen (1935) were soon abandoned for two main reasons. First, FDI involves the transfer of other resources than capital (technology, management, organizational and marketing skills, etc.) and it is the expected return on these, rather than on the capital per se, which prompts enterprises to become MNEs. Thus capital is simply a conduit for the transfer of other resources rather than the raison d’être for direct investment. Second, in the case of direct investment, resources are transferred internally within the firm rather than externally between two independent parties: de jure control is still retained over their usage. Furthermore, without this control, resources which are transferred may not have been transferred, and the production function of the receiving firm is different from what it would otherwise be. These are the essential differences between portfolio and direct investment.

If international capital theory could not explain international production, what could? In the 1950s and early 1960s there were two main approaches, viz. the ‘why’ or ‘how it is possible’ approach, based on industrial organization theory, and the ‘where’ approach, based upon location theory. The former concentrated on identifying the characteristics of MNEs that gave them production or transactional advantages over other firms that might otherwise supply the same foreign markets. Though the gist of this idea was contained in the work of Southard (1931), Barlow (1953), Penrose (1956) and Bye (1958), it was left to Stephen Hymer, in his seminal doctoral thesis (Hymer, 1960, 1976), to develop and formalize it into a separate theory of foreign direct investment. Based on an internationalization of Bain’s notion of barriers to entry (Bain, 1956), Hymer’s theory was essentially that firms undertaking foreign direct investment operated in an imperfect market environment, where it was necessary to acquire and sustain certain net advantages vis-à-vis firms in the countries in which they operated. The identification and evaluation of these advantages commanded much of the attention of economists in the late 1960s and early 1970s.

The second approach tried to answer the question, ‘Why do firms produce in one country rather than another?’ The pioneering work of Frank Southard in American Industry in Europe followed this approach, as did that of the authors of most of the early country case studies published between 1953 and 1970.³ In most cases the influences on location were extracted from field study data, and, occasionally, ranked in significance.⁴ Later, when more complete statistics were available, regression analysis was used to identify the main factors leading to US investment in Europe and Canada.

For the most part, these two approaches to explaining international production evolved independently of each other, and for this reason, if no other, neither was wholly satisfactory. The industrial organization approach did not answer where O advantages were exploited; the location theory approach did not explain how it was that foreign owned firms could outcompete domestic firms in supplying their own markets. Neither approach attempted to explain the dynamics of foreign investment. In this respect, the work of Raymond Vernon and his colleagues on the product cycle theory (Vernon, 1966; Wells, 1972) was of particular value, partly because it treated trade and investment as part of the same process of exploiting foreign markets, and partly because it explained this relationship in a dynamic context. To the questions of ‘why’ and ‘where’, Vernon added ‘when’ to the theory of foreign investment.

Advances in the theories of international production since the early 1970s have taken four main directions. First, there have been extensions of the industrial organization approach. These have focused on identifying and evaluating which of the advantages are most likely to explain patterns of foreign direct manufacturing investment. Here, perhaps, the work of Caves (1971, 1974a, b, c) has been the most extensive, but that of others, notably Johnson (1970), Wolf (1977), Ozawa (1979), Lall (1980), Pugel (1981), Owen (1982) and Swedenborg (1979) have also contributed to our understanding. Of the O advantages which might explain such investment, superior technology and innovative capacity in the case of production goods; and product differentiation, in the case of consumer goods, are shown to have to have the best explanatory power.

Second, there has been a resurgence of interest in some of the financial aspects of the foreign activities of firms. There have been a series of strands, but most can be classified into two groups: first, those which emphasize the imperfections of foreign exchange and capital markets, e.g. Aliber (1970, 1971, 1983); and, second, those which extend portfolio theory to explain the industrial and geographical distribution of foreign activities to take account of risk diversification and the stability of earnings. Here the work of Lessard (1979) and Rugman (1979) is particularly illuminating.

Third, there has been a major new theoretical thrust in seeking an explanation for international production as an extension to the theory of the firm. This reflects a switch in attention from the act of foreign direct investment, which is now recognized as a particular form of involvement by firms outside their national boundaries, to the institution making the investment. The main approach here has been to apply the theory of market failure to explaining the activities of MNEs, using the principles first expounded by Coase (1937) and Penrose (1956, 1958) but later refined and extended by Arrow (1969), Alchian and Demsetz (1972) and Williamson (1975) in their analysis of information markets and the economics of transaction costs. In the later 1970s and early 1980s, various economists, e.g. McManus (1972), Brown (1976), Buckley and Casson (1976), Magee (1977), Hennart (1982, 1986), Rugman (1981, 1982, 1986), Teece (1981a, 1985, 1987), Swedenborg (1979) and Calvet (1980) have sought to explain the propensity of firms to engage in foreign direct investment as a response to market failure. The basic proposition is that market failure in intermediate product markets and the need for firms to exploit the economies of interdependent activities, lead them to replace the market mechanism of cross-border transactions by internal hierarchies.

This approach helps explain by which route a firm chooses to exploit any advantages it possesses over its foreign competitors (although the route itself may sometimes affect these advantages): this question was largely ignored in the early literature on international production. The problem of choosing between a different set of options of servicing a foreign market was first taken up systematically by Hirsch (1976), who produced a model identifying the conditions under which a firm ...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Original Title Page
• Original Copyright Page
• Dedication
• Table of Contents
• Acknowledgements
• List of Figures
• List of Tables
• Introduction
• 1 Trade, Location of Economic Activity and the Multinational Enterprise: A Search for an Eclectic Approach
• 2 The Eclectic Paradigm of International Production: A Restatement and some Possible Extensions
• 3 Changes in the Level and Structure of International Production: The Last 100 Years
• 4 Some Historical Antecedents to the Eclectic Paradigm
• 5 The Investment Development Cycle and Third World Multinationals
• 6 Non-Equity Forms of Foreign Economic Involvement and the Theory of International Production
• 7 Explaining Intra-Industry International Production
• 8 US and Japanese Manufacturing Affiliates in the UK: Comparisons and Contrasts
• 9 The Eclectic Paradigm and the International Hotel Industry
• 10 Multinational Enterprises in the Business Services Sector: A Study in Locational Choice
• 11 Cross-Border Corporate Integration and Regional Integration
• 12 Towards an Interdisciplinary Explanation of International Production
• 13 The New-Style Multinationals - Circa the Late 1980s and Early 1990s
• References
• Index