Theories Of International Investment d3e6d

Name Roll No. Class Sub

K. Murugasen 09MBA29 II MBA; V Trimester International Business

Seminar title

Management Theories of International Investment

Date of

30December 2010

submission

THEORIES OF INTERNATIONAL INVESTMENT

Introduction: A number of attempts have been made to formulate a theory to explain the international investment. A brief outline of the important attempts in this direction is given below:  Theory of Capital Movements: The earliest theoreticians, who assumed, in the classical tradition, the existence of a perfectly competitive market, considered foreign investments as a form of factor movement to take advantage of the differential profit. The validity of this theory is clear from the observation of the noted economist Charles Kindleberger that under perfect competition, foreign direct investment would not occur and that would be unlikely to occur in a world wherein the conditions were even approximately competitive.  Market Imperfections Theory: One of the important market imperfections approach to the explanation of the foreign investment in the Monopolistic Advantage Theory propounded by Stephen in 1960. According to this theory, foreign direct investment occurred largely in oligopolistic industries rather than in industries operating under near perfect competition. Hymer suggested that the decision of a firm to invest in foreign markets was based on certain advantages the firm possessed over the local firms (in the foreign country) sucli as economies of scale, superior technology or skills in the fields of management, production, marketing and finance.  Internalization Theory: According to the internationalization theory, which is an extension of the market imperfections theory, foreign investment results from the decision of a firm to internalize a superior knowledge (i.e., keeping the knowledge within the firm to maintain the competitive edge)? For example, if a firm decides to externalize its know-how by licensing a foreign firm, the firm (the licensor) does not make any foreign investment in this respect but on the other hand, if the firm decides to internalize, it may invest abroad in production facilities. Methods of internalization include formal ways like patents and copy rights and informal ways like secrecy and family networks.

 Appropriability Theory: A firm should be able to appropriate (to keep for its exclusive use) the benefits resulting from a technology it has generated. If this condition is not satisfies, the firm would not be able to bear the cost of technology generation and, therefore, would have no incentive for research and development. MNCs tend to specialize in developing new technologies which are transmitted efficiently through their internal channels.  Location Specific Advantage Theory: The location specific advantage theory suggests that foreign investment is pulled by certain location specific advantages. According to Hood and Young, there are four factors which are pertinent to the Location Specific Theory. They are: 1. Labour costs 2. Marketing factors (like market size, market growth, stages of development and local competition) 3. Trade barriers 4. Government policy  International Product Life Cycle Theory: According to the Product Life Cycle Theory developed by Raymond Vernon and Lewis T. Wells, the production of a product shifts to different categories of countries through the different stages of the product life cycle. According to this theory, a new product is first manufactured and marketed in a developed country like the US (because of favorable factors like large domestic market, entrepreneurship and ease of organizing production). It is then exported to other developed markets. As competition increases in these markets, manufacturing facilities are established there to cater to these markets and also to export to the developing countries. As the product becomes standardized and competition further intensifies, manufacturing facilities are established in developing countries to lower production costs and due to other reasons. The developed country markets may also be serviced by exports from the production units in the developing countries.

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Eclectic Theory:

John Dunning has attempted to formulate a general theory of international production by combining the postulates of some of the other theories. According to Dunning, foreign investment by MNCs results from three competitive advantages which they enjoy, viz., 1. Firm specific advantages 2. Internalization advantages 3. Location specific advantages Firm specific advantages result from the tangible and intangible resources held exclusively, at least temporarily, by the firm and which provide the firm a comparative advantage over other firms. 

Other Theories:

According to Knickerbocker’s theory of Oligopholistic Reaction and Multinational Enterprise, when one firm, especially the leader in an oligopolistic industry, entered a market, other firms in the industry followed as a defensive strategy, i.e., to defend their market share from being taken away by the initial investor with the advantage of local production.