Theories of Foreign Direct Investment (Research Paper Sample)

How do the main theories of foreign direct investment explain the changing patterns FDI flows, from a transatlantic phenomenon 50 years ago, to a global phenomenon now?
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How do the main theories of foreign direct investment explain the changing patterns FDI flows, from a transatlantic phenomenon 50 years ago, to a global phenomenon now?
Before Hymer’s work in the 1960s, foreign direct investment was not considered as a distinctive phenomenon by economists. The multinational enterprise (MNE) was just another arbitrageur of capital, moving equity from low returns nations to where returns were slightly higher making profits of arbitrage at the same time contributing to the worldwide circulation of capital. As per Hymer’s perspective capital arbitrage theory and resource transfer of multinational enterprise, activities were quite at odds (1970, pp. 441-443). Multinational enterprises borrowed and invested abroad. Also, there was significant cross movement within industries internationally. Most importantly, multinational corporations were and are still focused more on certain specific industries such as petroleum, autos, chemical and electronics and less on others such as agriculture, steel and textiles. Additionally, the capital transfer is from a developed economy to another developed economy and not to a developing economy.
Hymer further advanced his theory by adding two reasons why firms decide to expand beyond their national boundaries. One was that firms tend to move beyond their territories to either attenuate competition by either displacing or buying it up. The second reason was that firms move to employ its special advantages such as entrepreneurship, skills, or access to capital that would otherwise be more potent in other territories than at home (Hymer, 1970, p. 443). On the other hand, the industry could either export its commodities or license a foreign enterprise but to avert possible technological misappropriation, bilateral monopoly scenarios, and cost between the licensor and licensee firms tend to invest instead.
Other scholars such as Mark Casson, John Dunning, Richard Caves, Alan Rugman, Charles and Oliver Williamson among other picked up from Hymer and developed their theoretical perspectives that either criticised or conquered with that proposed by Hymer. Most of the ideas and arguments raised by these scholars stem from Stephen Hymer’s Dissertation published in the 1976 (Hymer, 1970). These numerous theoretical perspectives demonstrate the multidisciplinary nature of the subject. Also, a consensus is lacking regarding the cross-national studies’ conceptual domain (Morgan & Katsikeas, 1997, p. 68). On a lighter note, the proliferations of the focuses and diversity of these cross-national studies greatly contribute to both macro and micro level analysis and understanding of the "cross-national commercial activities and operations" (Morgan & Katsikeas, 1997, p. 68).
Production Cycle Theory of Vernon
Substantial technological changes took place in the 1960s. At the same time, there was a rise in multinational enterprises. This has led to a continuous outgrowth of output for multinational firms ultimately resulting in the transformation of the structure of international trade to a greater extent. The significance of Foreign direct investment has even surpassed that of international trade (Densisia, 2010, p. 106; Nayak & Choudhury, 2014, p. 13). Theory of international theory (Smith, 1977; Ricardo, 1817) and the factor proportion theory (Heckscher, 1997; Ohlin, 1933) cannot explicitly answer questions regarding production outside its country’s borders (Nayak & Choudhury, 2014, p. 13). Vernon’s theory tries to assimilate international investment with international trade. Therefore, it becomes relatively clear how factors such as superior management, availability of cheaper capital, product differentiation and discovery of new processes interact to influence decisions on "production, export and foreign investment patterns of oligopolistic enterprises" (Nayak & Choudhury, 2014, p. 106).
Figure SEQ Figure \* ARABIC 1: Production Cycle TheoryTimeQuantityOStage 1Stage 2Stage 3Stage 4Stage 5ImportExportImportExportConsumptionProductionConsumptionProductionImitatorInnovator
Source: [Available at http://people.hofstra.edu/geotrans/eng/ch5en/conc5en/img/productlifecycle.gif], (Accessed 08.12.2015).
Production cycle has four stages; "innovation, growth, maturity and decline" (Densisia, 2010, p. 106) in which United States first becomes the exporter, losses its exports and eventually become an importer (Vernon, 1966, p. 192). Research studies carried out after Vernon proposed this theory indicate that electronic products, synthetic products, office machinery, motion pictures and consumer durables follow same cycle of international trade to the one Vernon proposed (Wells, 1968, p. 1). In Phase I: by assuming that United States lacks monopoly or basic technical know-how, but they have information about a particular market consisting of high-income consumers. By identifying this specific market, products can be introduced in the United States that specifically satisfy the target consumers (Vernon, 1966, pp. 192-93). Therefore, United States offers the best expert opportunities; by introducing products that target specific consumers and also due to its monopoly position.
In the early stages of products’ life, the production design is often in a state of uncertainty. A manufacturer close to the market is at an advantage since demands for design changes can be translated to develop the most suitable products. Additionally, these design changes can close communications between the manufacturer and the suppliers (Vernon, 1966, p. 192). The main concern is instability of product design. In the maturing stage, the company can now expand and invest in countries where there is sufficient demand to warrant the products’ production facilities. The manufacturer would be prompted to establish manufacturing units in other advanced nations. According to Vernon, this stage is characterized by a decline in the need for flexibility. Also, concerns about cost rather the product increases. However, the necessity of flexibility may be reduced as the product matures since demand and standardization increases coupled with long-term commitments and expectations of higher economies of scale.
Also in the early stages of product’s life cycle, value added contribution by skilled labour contributes to increased labour cost but later increase in output and decreased level of uncertainty justifies the capital intensive investment. At this stage, companies target higher economies of scale. To achieve this firms are prompted to set up their facilities in regions with low labour cost and in turn now export products to United States. In this case, target regions include those of developing nations. This implies that developing nations now provide competitive advantages as productions sites. The company sets up a production facility in developing nations to reduce costs, competition and serve its global market.
Theory of Market Imperfections
It was brought forward by Hymer and is states that a company’s decision to invest outside its national borders is "explained as a strategy to capitalize on certain capabilities not share by competitors in foreign countries" (Hymer, 1970, as cited by Morgan & Katsikeas, 1997, p. 70). This implies that advantages or capabilities of a firm are determined by certain "market imperfections for products and factors of production" Ibid. Therefore, firms are prompted to manufacture homogenous products that will enjoy the same level as that of factors of production. However, according to Morgan and Katsikeas (1997) in reality market imperfections dictates that market acquires diverse types of competitive advantages of varying degrees. One weakness of the theory as highlighted by numerous scholars is that it fails to offer a substantial explanation as to why foreign production is highly regarded as one of the key strategies of harnessing firm’s advantages CITATION Mor97 \p 107 \l 1033 (Morgan & Katsikeas, 1997, p. 107).
International Production Theory
It was developed by Dunn (1980) to address an issue related to Market Imperfections Theory. This theory suggests that initial foreign production is dependent on certain unique attractions within its home country in comparison with resource implications and competitive advantages of investing in another country. This implies that decision to invest overseas is not only determined by resource differentials and competitive advantages but also foreign governmentent policies may have a great impact on the "peace meal attractiveness" for firms.
Internalization Theory
It was developed by Buckley and Casson study in 1976. According to this theory, companies prefer to foreign direct investment than carrying our productions in their home country.. a situation wherey companies in an imperfect competition environment maximize their profits. Imperfections include, high transport costs, trade barriers, inadequate foreign market data, transaction costs among others Advantages of internalization can be explained in two approaches. The first approach emphasizes on technological transfer. Most often technology comes with certain difficulties. for instance, potential buyer find it difficult to appraise the value of knowledge. Besides, it is impossible to pack and sell knowledge CITATION Ali \p 8 \l 1033 (Dulupçu & Onur, 2005, p. 8). It is also difficult to secure intellectual property rights. Therefore , it is , more profitable for a multinational ...