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1 Foreign Direct Investment Articles Foundation There are two problems with classical trade theories: 1- those theoretical models do not have enough variables to explain such a complex and dynamic phenomenon of globalization and emergence of multinationals. 2- There is a defect in the methodology and concept frameworks of theories do not let us to create a cumulative structure of theoretical empirical concepts that provide purpose to subsequent studies. Product Life Cycle Theory (Vernon, 1966,1971 & Wells, 1968, 1969) Production cycle theory developed by Vernon in 1966 was used to explain certain types of foreign direct investment made by U.S. companies in Western Europe after the Second World War Vernon believes that there are four stages of production cycle: innovation, growth, maturity and decline. According to Vernon, in the first stage the U.S. transnational companies create new innovative products for local consumption and export the surplus in order to serve also the foreign markets. According to the theory of the production cycle, after the Second World War in Europe has increased demand for manufactured products like those produced in USA. Thus, American firms began to export, having the advantage of technology on international competitors. If in the first stage of the production cycle, manufacturers have an advantage by possessing new technologies, as the product develops also the technology becomes known. Manufacturers will standardize the product, but there will be companies that you will copy it. Thereby, European firms have started imitating American products that U.S. firms were exporting to these countries. US companies were forced to perform production facilities on the local markets to maintain their market shares in those areas. In Honor of Stephen H. Hymer: The First Quarter Century of The Theory of Foreign Direct Investment. Dunning & Rugman The great contribution of Stephen Hymer’s seminal dissertation (1960) was to escape from the neo-classical-type trade and financial theory, and move us toward an analysis of the multinational enterprise (MNE) based upon industrial organization theory. In 1960 the prevailing explanation of international capital movements relied exclusively upon a neoclassical financial theory of portfolio flows. In this frictionless world of perfect competition, with no transaction costs, capital moves in response to changes in interest rate (or profit) differentials. According to this arbitrage theory, capital is assumed to be transacted between independent buyers and sellers, that is, there is no role for the MNE. At that time there was no separate theory of foreign direct investment. Hymer’s great insight was in focusing attention upon the MNE as the institution for international production, rather than international exchange. Before Hymer, no way to understand why the MNE transfer intermediate products such as knowledge or technology among different countries. Today, it is widely recognized that the theory of FDI is primarily about the transfer of nonfinancial and ownership specific intangible assets by the MNE, which needs to appropriate and control the rate of use of its internalized advantages. Structural or Transaction-Cost Markey Imperfection? Hymer explains that the MNE is a creature of market imperfections. The MNE has ability to use its international operations to separate markets and remove competition, or to exploit an advantage. In this case, Hymer misses the distinction between structural and transaction-cost market imperfection made. Efficiency and Strategic Management: Hymer should receive credit for directing attention towards the ability of MNEs to close markets by the strategies which are now the basic tools of business management policy. Dynamics and Diversification: There are two other areas of theorical interest in Hymer’s dissertation. The first is his emphasis upon market structure and the dynamic nature of the ownership-specific advantages of MNEs. This is consistent with the dynamic modeling of product life cycles and the oligopolistic reaction of MNEs. The second area of interest in Hymer’s insight into the advantages of international diversification. In this regard, he foresees the role of the MNE as an indirect vehicle for the achievement of the gains from international diversification in a world where individuals face transaction costs in undertaking such diversification themselves. Hymer and Policy: He does not deal with policy and he has little to say about the political or social issues of developing nations. The Eclectic Paradigm of International Production: A Restatement and Some Possible Extensions (John H. Dunning) The article consist of two parts: 1- reviews some of the criticisms directed towards the eclectic paradigm of international production over the past decade, and restates its main tenets. 2- The second part of the article considers a number of possible extensions of the paradigm and concludes by asserting that it remains. The intention of the eclectic paradigm was to offer a holistic framework by which it was possible to identify and evaluate the significance of the factors influencing both the initial act of foreign production by enterprises and the growth of such production. It is accepted that, precisely because of its generality, the eclectic paradigm has only limited power to explain or predict particular kinds of international production and even less, the behaviour of individual enterprises. But this deficiency, which some critics have alleged, could no less be directed at attempts to formulate a general but operationally testable paradigm of international trade. The classical and neoclassical theories of trade, for example, while still having wide explanatory powers for most kinds of inter-industry trade are quite inadequate to explain much of intra-industry trade. Indeed it is perhaps worth emphasizing that the point at which the Heckscher-Ohlin-Samuelson (H-O-S) theory of trade fails is precisely that at which the modern paradigm of international production starts, namely the point at which there are positive transaction costs in intermediate good markets. The difference between the neo-technology and other modern theories of trade and those of international production is that, while the former implicitly assume that all goods are exchanged between independent buyers and sellers across national frontiers, the latter explicitly postulate that the transfer of intermediate products is undertaken within the same enterprises. In other words, without international market failure, the raison d'etre for international production disappears. But once it exists, explanations of trade and production may be thought of as a part of a general paradigm based upon the international disposition of factor endowments, and the costs of alternative modalities for transacting intermediate products across national boundaries. This is the central theme of this paper. CRITICISMS OF THE ECLECTIC PARADIGM Are Competitive or Ownership Advantages Necessary to Explain International Production? In its original form, the eclectic paradigm stated that the international production was determined by the configuration of three sets of advantages as perceived by enterprises. First, in order for firms of one nationality to compete with those of another by producing in the latter's own countries, they must possess certain advantages specific to the nature and/or nationality of their ownership. These advantages sometimes called competitive or monopolistic advantages must be sufficient to compensate for the costs of setting up and operating a foreign value-adding operation, in addition to those faced by indigenous producers or potential producers. In our 1976 paper we identified three types of ownership-specific advantages: (a) those that stem from the exclusive privileged possession of or access to particular income generating assets, (b) those that are normally enjoyed by a branch plant compared with a de novo firm, and (c) those that are a consequence of geographical diversification or multinationality per se. Later Dunning distinguished between the asset (Oa) and transaction (Ot) advantages of multinational enterprises (MNEs). While the former arise from the proprietary ownership of specific assets by MNEs vis-a-vis those possessed by other enterprises, the latter mirror the capacity of MNE hierarchies vis-a-vis external markets to capture the transactional benefits (or lessen the transactional costs) arising from the common governance of a network of these assets, located in different countries. The distinction between structural and transactional market imperfections is an important one (Dunning and Rugman 1985). Clearly the relevance of each in determining the ownership advantages of MNEs will vary according to the characteristics of firms, the products they produce, the markets in which they operate, and whether the competitive process is viewed from a static or dynamic perspective. The second condition for international production is that it must be in the best interests of enterprises that possess ownership-specific advantages to transfer them across national boundaries within their own organizations rather than sell them, or their right of use to foreign-based enterprises. This immediately suggests that MNEs perceive that the international market place is not the best modality for transacting intermediate goods or services. The reasons for the internalization of market can be market failure. The three main kinds of market failure are usually identified as: those from risk and uncertainty, those from the ability of firms to exploit the economies of large-scale production, but only in an imperfect market situation, and from high transactions cost of a particular goods and services. The desire by firms to integrate different stages of the value-added chain, to engage in product diversification, or to capture the economies of the use of complementary assets, originate from the presence of one or other of these forms of transactional market failure even though the motives for internalization may be expressed rather differently. The greater the perceived costs of transactional market failure, the more MNEs are likely to exploit their competitive advantages through international production rather than by contractual agreements with foreign firms. By contrast, the higher the administrative costs of hierarchies and/or the external diseconomies (or disbenefits) of operating a foreign venture, the more probable the latter vehicle (or at least a jointly shared equity stake) will be preferred. Certainly in the exploitation of specific intangible assets (Oa) (e.g., a patent or trade mark), firms often have a choice between using the external market or not. Here the distinction between asset generation, or acquisition, and asset usage is an important one. We would accept with Rugman (1981) that, if an ownership advantage is either created by or becomes the exclusive property of a particular enterprise, it has in some sense "internalized" the market for its use; but we believe this to be a questionable extension of the interpretation of a term that originally and quite specifically was intended to convey a response to transactional rather than structural market failure. Locational Advantages: Structural and Transactional Market Failure The third strand of the eclectic paradigm is concerned with the "where" of production. Enterprises will engage in foreign production whenever they perceive it is in their best interests to combine spatially transferable intermediate products produced in the home country, with at least some immobile factor endowments or other intermediate products in another country. While, in the eclectic paradigm, the advantages or disadvantages of particular locations are treated separately from the ownership advantages of particular enterprises, and while the market for these advantages are internalized; the decision on where to site a mine, factory or office, is not independent of the ownership of these assets nor of the route by which they or their rights are transacted. Similarly, the choice of location may be prompted by spatial