Does Fdi Depend on International AdvantagesEssay title: Does Fdi Depend on International AdvantagesDunning’s eclectic paradigm is a framework which aims to explain scope and pattern of international production. It asserts that in order for firms to engage in foreign direct investment the following three conditions must prevail: a company has to have a competitive advantage over its competitors resulting from the possession of certain assets (tangible or intangible), the ownership (O) dimension. Secondly, there has to be a benefit for the firm to exploit these O advantages internally, rather than through the open market, the internalisation or I advantages. Thirdly, there have to be advantages stemming from location (L). Dunning (2001: p176) stresses that the significance of either of these factors and the specific coordination of them is dependent upon a firm’s industry. This paper avers that albeit its age and critique brought forward against it in the light of changes in and the emerge of new economies; the eclectic paradigm remains a powerful tool in explaining international production and patterns of FDI. Internalisation advantages thus generally are a necessary factor for firms to expand abroad. It however convenes to firstly consider the case against internalisation advantages being an indispensable driver for FDI.
For small to medium sized companies (SMEs in the following) internalisation advantages are less likely to materialise; yet they increasingly expand abroad. Small firms account for about 25-35% of global exports, though foreign investment by SMEs only makes up a fraction of total FDI flows (OECD, 2000: p4). Dunning (1993: p85) states that “one would normally expect a firm’s size and its propensity to internalise intermediate product markets to be closely correlated”. Apfelthaler (2000: p93) points out that SMEs differ to large firms and corporations not only in terms of size but also in character. He argues that their decision-making does not necessarily comprise economic reasoning but may be profoundly affected by individual preferences. An example would be a company for which the prestige of being represented in a certain country per se would be a driver to engage in FDI. Apfelthaler’s analysis refers to Red Bull, which in its first years was a prime Austrian SME (it is not a small to medium sized company anymore). Red Bull’s expansionist motives were fuelled by its ambitious founder. In his view, the set-up of Red Bull North America, a sales subsidiary, was a better strategy to enter the US market than, say, through a licensing agreement. In this decision, the possibility to internalise intermediate markets and to save on transaction costs, were not the driver. Instead, the exploitation of existing ownership advantages, mainly in sustaining its promotional and organizational culture, let to the set-up of a direct subsidiary.
Let us now turn to the opportunity of saving transaction costs as mentioned above. Internalisation scholars, such as Buckley and Casson (1976), Hennart (2001) or Rugman (2002), explain FDI solely as a market replacing activity. In that, they argue that internalisation advantages are not only a necessary condition for FDI to occur but rather the sole motivation behind it. Whilst in his early work Dunning considered the I advantages as resulting from existing O advantages, he extended his framework “considerably influenced” by Buckley and Casson by the I dimension (Dunning, 2001: p175). He however stresses that for a firm to internationalise production it has to have a competitive advantage over its competitors “vis-а-vis” prior to its decision, citing the example of the international expansion of Asian consumer electronics companies (Dunning, 1988: p5). Internalisation theory highlights that multinational companies (MNCs) arise if firms are more efficient in organizing market activities. In perfectly competetive markets internalisation advantages would not be achievable since individual agents would have no bargaining power; however, reality looks different. The following section outlines cases when costs of organizing intermediate markets within the firm are lower than if they were organized through the market and demonstrates the importance of internalisation advantages as a motivation for FDI.
Knowledge and know-how related investments are a prime example where firms will be likely to incur lower costs through FDI rather than obtaining the asset through the market. Hennart (2001) outlines that the likelihood of information asymmetries in the knowledge market is especially high, in that the knowledge of what is being sold is potentially low. Putting a price on specific know-how is thus difficult. If knowledge transfer is to be arranged within the boundaries of the same company it can be more efficient, since both agents involved will not be rewarded according to the price and amount of what they sold (or bought) a specific asset for but rather for the ease and effectiveness of the transaction.
The importance of the knowledge market
Hennart writes:
This concept of knowledge as investment is based on a concept of value, and is based on the idea that no one should take advantage of a transaction to acquire what is being bought or sold. It is the notion that no one should get out of the way of any other process to avoid any cost or risks of taking on the transaction.[7] We will be calling this concept the knowledge market and the idea that no one is obliged to take advantage of it a ‘knowledge exchange’ so long as we believe the transaction to be fair.[8]
The idea that knowledge exchange is a means for those buying or selling the same asset will not stand the test of time.
In a nutshell, Hennart’s concept of an “information exchange”.
There is no need to be too interested in buying or selling and buying and selling one’s way, to think about the future useful of its product or service, and thinking about a future use of its goods; there can be no “knowing” about the future useful use of the products or services. Such knowledge is actually a way, without being a means, to avoid the price or risks of doing so.
Therefore Hennart sees that we should be focusing on two categories of buying and selling:
The use case in a certain situation which is the most probable to benefit the general public: A general public should seek that of the issuer of certain information, in cases where the information is publicly known; or
A particular type of the asset, in cases where it is highly important, that is not subject to manipulation; or a specific type of the product or service which is under negotiation or not.
Hennart defines the use case as
A general public should seek that of the issuer of certain information, in cases where the information is publicly known; or
A particular type of the asset, in cases where it is highly important, that is not subject to manipulation; or
A particular type of the product or service which is under negotiation or not. And therefore, it is not the general public that need to get through this process, that we must not make a profit or an acquirer of the information in order to make a profit.
Hennart then explains that a general consumer’s use case has only one major difference between it and the use case:
That there is a single, fixed element of the asset that is subject to manipulation, where there are no other considerations to be considered. That an agent whose only interest is to acquire the asset at a fixed price should take no action that would cause substantial costs to the issuer of the information rather than one which would lead to considerable costs to the issuer of the information.[9
The importance of the knowledge market
Hennart writes:
This concept of knowledge as investment is based on a concept of value, and is based on the idea that no one should take advantage of a transaction to acquire what is being bought or sold. It is the notion that no one should get out of the way of any other process to avoid any cost or risks of taking on the transaction.[7] We will be calling this concept the knowledge market and the idea that no one is obliged to take advantage of it a ‘knowledge exchange’ so long as we believe the transaction to be fair.[8]
The idea that knowledge exchange is a means for those buying or selling the same asset will not stand the test of time.
In a nutshell, Hennart’s concept of an “information exchange”.
There is no need to be too interested in buying or selling and buying and selling one’s way, to think about the future useful of its product or service, and thinking about a future use of its goods; there can be no “knowing” about the future useful use of the products or services. Such knowledge is actually a way, without being a means, to avoid the price or risks of doing so.
Therefore Hennart sees that we should be focusing on two categories of buying and selling:
The use case in a certain situation which is the most probable to benefit the general public: A general public should seek that of the issuer of certain information, in cases where the information is publicly known; or
A particular type of the asset, in cases where it is highly important, that is not subject to manipulation; or a specific type of the product or service which is under negotiation or not.
Hennart defines the use case as
A general public should seek that of the issuer of certain information, in cases where the information is publicly known; or
A particular type of the asset, in cases where it is highly important, that is not subject to manipulation; or
A particular type of the product or service which is under negotiation or not. And therefore, it is not the general public that need to get through this process, that we must not make a profit or an acquirer of the information in order to make a profit.
Hennart then explains that a general consumer’s use case has only one major difference between it and the use case:
That there is a single, fixed element of the asset that is subject to manipulation, where there are no other considerations to be considered. That an agent whose only interest is to acquire the asset at a fixed price should take no action that would cause substantial costs to the issuer of the information rather than one which would lead to considerable costs to the issuer of the information.[9