PD2 - Research Paper. Rozen-Bakher, Z. Are Multinational Enterprises’ (MNEs) Theories explained the reality of Foreign Direct Investment (FDI) and International Trade in the 21st Century?

Rozen-Bakher, Z. Are Multinational Enterprises’ (MNEs) Theories explained the reality of Foreign Direct Investment (FDI) and International Trade in the 21st Century?. Research Paper, PD2. https://www.rozen-bakher.com/research-papers/pd2

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Rozen-Bakher, Z.

Rozen-Bakher, Z. Are Multinational Enterprises’ (MNEs) Theories explained the reality of Foreign Direct Investment (FDI) and International Trade in the 21st Century?

Abstract

This study explores the main theories of MNEs from the perspective of the 21st century to understand if these theories still explain the current reality of FDI and international trade. The study examined nine theories: Mercantilism, Absolute Advantage, Comparative Advantage, Factor Proportions, Hymer’s Contribution, Product Life Cycle, Internalization, Eclectic Paradigm, and Diamond Model. The study suggests that the current Mercantilism wave rattles many MNEs due to trade wars to accomplish nationalism agenda, while the liberalization of the Comparative Advantages has faded following the failure of Doha Round. However, Vernon’s theory is needed to adjust to the current reality of MNEs via the concept of a short Product Life Cycle that impacts the timing of moving the international production to low-cost host countries. Absolute Advantage and Hymer’s Contribution did not reflect the current market conditions, while the theories of Dunning and Porter still explain the current complexity of MNEs.

Keywords: Theories, Multinational Enterprises (MNEs), Foreign Direct Investment (FDI), International Trade  

1.      Introduction

This study explores the main theories of Multinational Enterprises (MNEs) that have evolved over the centuries, either international trade theories or Foreign Direct Investment (FDI) theories, yet from the perspective of the 21st century to understand if these theories still explain the current reality of MNEs activities. The literature distinguishes between international trade and FDI. International trade (Feenstra, 2015; Viner, 2016) refers to the exchange of goods and services between different countries (Andraz & Rodrigues, 2010; Branch, 2006; Daniels & Radebauge, 2002; El-Gohary et al., 2013), while FDI refers to investments that carry out by MNEs in host countries when the MNEs have control in at least 10% of the acquired activity in the host country (Dunning, 2013a, 2014; Dunning & Lundan, 2008). (Dunning & Lundan, 2008; Hertenstein et al., 2017; Li et al., 2012; Poncet, 2010; Rozen-Bakher, 2017). Hence, the significant differences between international trade and FDI lie in the capital required to carry out FDI, alongside the exposure to risks when an MNE operates in a host country (Dunning & Lundan, 2008). In other words, in international trade, MNEs are located in the home country, and operate from the home country through local entities in host countries or directly through online trading, while in FDI, an MNE invests capital to establish its operation in the host country, but it needs to operate under the rules and laws of the host country. Given that, when an MNE conduct FDI in a host country, the activity could expose to risks due to various reasons, such as political instability.

Considering the above, literature suggests various definitions for the term MNEs (Dunning & Lundan, 2008; Markusen, 1995), yet they reflect the differences between FDI and international trade namely, some researchers define an MNE as a company that engages in international trade or FDI (e.g. Hill, 1994), while other researchers define an MNE as a company who deals only in FDI (e.g. Dunning & Lundan, 2008). Thus, researchers mainly differ from each other in relation to international trade. Lilienthal (1960) was the first to coin the term "MNEs". He defined it as companies that have a home in a single country, but they operate simultaneously under the laws and procedures of other host countries (Lilienthal, 1960). Kindleberger (1969) defined MNEs as companies that have no loyalty to a single country over another, and the management considers the capital return after weighing the risks involved in each country. Aharoni (1971) defined an MNE as a single company whose management controls a cluster of companies, but each of the companies operates in a different host country. Buckley and Casson (1976) defined an MNE as a company that owns and controls activities in different host countries. Caves (1996) defined an MNE as an organisation that controls and manages production at several sites located in at least two different host countries. Hill (1994) defined MNEs as companies that involve in international trade or foreign direct investment (FDI). Rugman and Hodgetts (1995) defined an MNEs as a company that its headquarters are located in a single country and its activities are located in at least two or more host countries. Deresky (1997) defined an MNE as a company that engages in production or service activities through its affiliates in different host countries. Daniels and Radebauge (2002) defined an MNE as a company that adopts a global approach to production and foreign markets. Dunning and Lundan (2008) defined an MNEs as a company that engage in FDI, and in some way, it owns and controls other companies in more than one host country, yet a company can be considered as an MNE only if it engages in FDI because of the risks that involve entry to host countries. However, others argued that the entry modes of MNEs include not only the FDI but also the international trade, such as export, licensing, and franchising (Andraz & Rodrigues, 2010; Branch, 2006; Dratler Jr, 2018; El-Gohary et al., 2013; Krug & Daniels, 2008; Sherman, 2011), so it's important to include the activity of international trade as part of the definition of MNEs because in many cases, international trade is carried out as preliminary activity before conducting FDI, while in other cases, it is carried out as a complementary activity or as an alternative activity, especially when exists a high risk for FDI in the host country. Considering that, the research literature strives to explain the MNE activity through various theories that were evolved over the centuries. Nonetheless, the differences between these theories stem from the theory's questions, the perspectives and the unit of analysis (Dunning & Lundan, 2008; Morgan & Katsikeas, 1997).

2.      Classical Theories of International Trade

Classical theories of international trade focus on international business activity at the country level, rather than on the MNEs per se (Dunning & Lundan, 2008). Nevertheless, they significantly contributed to the development of modern theories aims at explaining the MNE activity. Thus, the classical theories are important for the understanding of MNE activity (Dunning & Lundan, 2008). The objective of the classical theories of international trade was to address serious questions from the home country perspective, such as why a home country should engage in international trade? Why it's worthwhile to engage in international trade? Which products are worthwhile for trade with other host countries? Which host countries have priority for trade with the home country? (Daniels & Radebauge, 2002; Dunning & Lundan, 2008; Mun, 1895 (Reprint 1664); Vernon, 1966). The classical theories also contributed to the understanding of MNEs' entry modes alongside the development of public policy that deals with the outcomes and implications of MNEs' activities. 

2.1 Mercantilism Theory

Mercantilism developed due to the creation of the nation-state following the fall of the feudal state alongside the transition to a centralised economy (Stern & Wennerlind, 2013). Mercantilism became a dominant economic doctrine between the 16th and 18th centuries (LaHaye, 2017). However, economists have shown recently renewed interest (Conti, 2018) in this controversial doctrine due to Trump's policy of "America First" (ECONOMIST, 2016). Notably, the American and global press tend to refer "America First" as a "nationalism" policy (ECONOMIST, 2016) because of the expectation that it may lead to severe problems at the geopolitical level and even to international security complications (Conti, 2018). This is regardless of the consequences of "trade wars" due to the restrictions on international trade and the deterioration of the international relations with countries who suffer from "America First". Nonetheless, regardless of the nationalism aspect, it can be argued that the policy of "America First" is based on the characteristics and principles of the Mercantilism theory (Mokyr PBS, 2017), as discussed in depth below.

Mercantilism is considered a prescriptive theory (Bell, 1988) that provides an economic doctrine to increase the wealth of a country. It was measured in the past based on the treasure of gold and silver that was possessed by the country (Czinkota et al., 2002). According to Mercantilism, a country could increase its wealth and national assets by creating a positive balance of trade with other countries (Conti, 2018; Mun, 1895 (Reprint 1664); Stern & Wennerlind, 2013). In other words, a creation of a maximum export and a minimum import along with government regulation in relation to a country's economy should lead to an economic strength of a country at the expense of rival countries (Czinkota et al., 2002).

Thomas Mun considers as the foremost theorist of Mercantilism theory. In his book "England's Treasure by Forraign Trade, 1964", Mun described the main objective of Mercantilism: "to sell more to foreigners during a year than we buy from them in terms of value" (Mun, 1895 (Reprint 1664). Thus, Mercantilism reflects a "zero-sum game" in which increasing the wealth of one country occurs at the expense of the wealth of a second country.

Mercantilism doctrine suggests four main ways to create a positive balance of international trade at a country level, which is implemented by maximising export along with minimising import (Conti, 2018; Czinkota et al., 2002; Daniels & Radebauge, 2002; Mun, 1895 (Reprint 1664); Stern & Wennerlind, 2013), as follows:

Government Subsidies to Encourage Export. One of the most important ways to maximise export is by providing government subsidies for local manufacturing in order to improve the competitive advantages of local companies in host countries. From the Mercantilism perspective, maximising export can be achieved by providing government subsidies to local companies. The subsidies are supposed to cover part of the firm's costs in order to sell the products at lower prices in host markets compared to the higher prices without government subsidies. In other words, in subsidisation, the product price is not determined by actual product cost but according to the offset by the government subsidies. Hence, export subsidies represent a type of government grant that improves the competitive advantages of local firms in host countries. Still, it's not necessarily thanks to the firm's management or its products, but due to the subsidies that cover part of the production costs. That contributes to the firm's ability to market its products at lower prices in host markets, regardless of their actual production costs.

Import Restrictions. The government imposes import restrictions on imported products through taxes, tariffs and quotas. That's done to achieve a minimal import by ensuring that the prices of imported products from other countries are less competitive compared to the prices of local products. In other words, the import is limited or blocked to provide an advantage to the consumption of local products over imported products aims at preventing a negative balance of international trade.

Limiting Consumption and Encouraging Savings. According to Mercantilism, it is necessary to limit consumption, especially of luxury goods, as well as to encourage the citizens to save money with the aim of preventing the wastes of the country's wealth. The consumption restrictions are imposed, especially regarding the outflow of funds from the home country to host countries by imposing high tariffs on luxury goods alongside high taxes and entry barriers. For example, in Israel, between the years 1950-1993, an "exit tax" was imposed on Israeli citizens who travel from Israel to foreign countries (Ben-Bassat, 2001) in order to prevent "unnecessary" spending of Israeli money in foreign countries. In other words, tourism in a host country leads the citizens of a home country to convert their local currency to the foreign currency in the host country. Thus, from the viewpoint of the home country, outgoing tourism is considered as an import, while incoming tourism is considered as an export. Given that, from the standpoint of Mercantilism, it's necessary limiting the outgoing tourism to minimise the import, along with encouraging the incoming tourism to maximise the export to achieve a positive balance of international trade.

Establishment of Colonies. Imperialism and colonialism serve as an essential tool for creating a positive balance of international trade. That's done by the occupation of host territories to establish colonies by the home country in order to obtain cheap natural resources and a low-cost labour force. Therefore, to maximise the positive balance of international trade through colonialism, the home country imposed strict regulations on its colonies in relation to production, international trade, and prices, as follows:

·      Production restrictions. Production restrictions were implemented by prohibiting production in colonies, except for the production of the home country in order to gain control over colonies' production for the exclusive benefit of the home country. Therefore, local production in the colonies was owned and controlled by the home country.

·      Trade restrictions. Trade restrictions were imposed to prevent the colonies to trade with other colonies or host countries without the involvement of the home country. Hence, trade was permitted only between the colony and the home country, or between the colony and other colonies, or between the colony and host countries, nonetheless only through the home country.

·      Price restrictions. Price restrictions were imposed in a way that the export of products and raw materials from the colonies to the home country was carried out at lower prices than the real value of the products and raw materials. In contrast, the import of products and raw materials from the home country to the colonies was carried out at higher prices than the real value of the home's products and raw materials. Hence, under this mechanism, the home country purchased products and raw materials from the colonies at low prices, while the colonies purchased products and raw materials from the home country at exorbitant prices.

2.2 Absolute Advantage Theory

The economist Adam Smith is considered as the 'father of modern economy', and in his book "An Inquiry into the Nature and Causes of the Wealth of Nations, 1776", he criticised Mercantilism (Schumacher, 2012). Smith argued that the wealth of a country doesn't derive from the country's treasury as the Mercantilism theory claims, but from the products and services that are available to all residents in a country (Smith, 1776). From the colony perspective, the Mercantilism encourages marketing of local products in the colonies at higher prices through monopoly production that is carried out in the colony by the home country, or through the import of products from the home country. Given that, Smith asked why citizens of a country should purchase local products at high prices if they could purchase the same products at lower prices in another country? (Daniels & Radebauge, 2002).

According to the Absolute Advantage Theory, countries differ from each other in production efficiency, and thereby, each country should produce products with an absolute advantage. Nevertheless, each country should purchase products at lower prices from other countries if the prices of the same local products are at higher prices compared to other countries (Smith, 1776). Based on this rationale, lifting the restrictions on international trade may contribute to global efficiency. Accordingly, each country will be able to produce products with maximum efficiency alongside allocating the required resources to achieve specialisation (Smith, 1776). Hence, according to Adam Smith, specialisation and professionalisation may contribute to the improvement of labour skills, as well as to the development of efficient work methods, but without waste of resources that may occur when labour production shifts from one industry to another industry (Smith, 1776). Notably, absolute advantage can be achieved through absolute natural advantage, such as using the natural resources and human resources that exist in a country to produce local products. It can also be achieved through acquiring an absolute advantage by using raw materials that are not necessarily local (Czinkota et al., 2002).

2.3 Comparative Advantage Theory

The British economist David Ricardo, in his book "On the Principles of Political Economy and Taxation, 1817", attempted to answer the question: What occurs when a country has an absolute advantage in many local products? To address this question, Ricardo developed the comparative advantage theory, based on the theory of absolute advantage. According to the comparative advantage theory, countries differ from each other in their production efficiency alongside utilising their resources. Thus, each country should produce a large number of products that it's able to produce more effectively. However, each country should purchase products from other countries when it's less effective to produce these products locally. Nonetheless, according to Ricardo, it should be done even if the country can produce these products more effectively than other countries which it buys from them these products (Ricardo, 1891; Watson, 2017). In other words, Ricardo explained why a country should trade with another country, even in a situation that the country can produce cheaper products compared to another country. More importantly, according to Ricardo, each country should prioritise its production, and thereby, produce only products with a comparative advantage, rather than with an absolute advantage (Ricardo, 1891). That is supposed to contribute to professionalisation and specialisation (Ricardo, 1891). Given that, it can be argued that the novelty of Ricardo's theory lies in the principle of the advantage of expertise. When a country splits its resources for too many fields, then it's may hinder the country's expertise in some of the fields. In contrast, when a country focuses only on a few fields, then it may increase its expertise in these fields.

Furthermore, Ricardo argued that restrictions and barriers in relation to international trade should remove in order to increase the output and efficiency at the global level. That may contribute not only to powerful and developed countries but also to developing and underdeveloping countries (Daniels & Radebauge, 2002). Hence, if each country will create expertise in a few fields, but will trade with other countries in its non-expertise fields, then it may increase the output and efficiency at the global level. That's based on the reasoning that each country may carry out production in the best possible way due to the advantages of the expertise. In spite of the above, there are researchers that interpreted Ricardo differently. For example, Baiman (2017) argued that the comparative advantage theory focuses on how to carry out and manage international trade, rather than on how to achieve free international trade.

2.4 Factor Proportions Theory

Ricardo's comparative advantage theory argues that countries differ in the efficiency of production. However, the comparative advantage theory does not address which type of products can provide a comparative advantage to the country. Hence, the Swedish economists Eli Heckscher (Eli Heckscher, 1919) and Bertil Ohlin (Bertil Ohlin, 1933) developed the Factor Proportions Theory (Onyemelukwe, 2016). Heckscher-Ohlin attempted to address the questions: What products a country should trade? And what products are worthwhile for trade? (Daniels and Radebaugh, 2002).

According to Heckscher-Ohlin, the comparative advantage of a country derives from the number of resources available within a country, rather than from the country's efficiency of production (Onyemelukwe, 2016). Hence, the quantity and quality of the resources available within a country may explain the difference in production costs among countries. Accordingly, countries should export products that their production resources in the country are available, while import products that their production resources in the country are limited (Heckscher & Ohlin, 1991; Onyemelukwe, 2016).

Furthermore, the factor proportions theory argues that a country has three main production factors (Flam & Flanders, 1991; Heckscher & Ohlin, 1991; Onyemelukwe, 2016), as follows: i) Natural resources. This factor refers to the availability and quality of a country's natural resources, such as oil, agricultural products, minerals and raw materials. ii) Human resources. This factor refers to the labour force in terms of availability, costs, and skills. iii) Capital resources. This factor refers to the availability and cost of the capital required for investments in a country, such as the capital that need for buying companies, assets and equipment, or for investments in R & D.

3.      Early Theories of MNEs' Activity

The classical theories of international trade provided explanations for the activity of international trade at a country level, but these theories did not deal directly with the activity of MNEs. However, since the beginning of the 1960s, have started to emerge theories that provided partial explanations for the activities of MNEs (Dunning & Lundan, 2008). In spite of that, these early theories served as a crucial stage for the development of MNEs' general theories in the following decades.

3.1 Hymer's Contribution

Stephen Hymer, in his doctoral dissertation "The International Operations of National Firms: A Study of Direct Foreign Investment, 1960", was the first one to explain FDI not only in terms of capital transfer, but also in terms of transfer of knowledge, technology, and assets (Dunning & Rugman, 1985). Accordingly, Hymer distinguished between the transfer of capital without control and the transfer of capital when a company has control over the target activity (Hymer, 1960). Notably, Hymer's theory is based on the Industrial Organisation Theory that focuses on international activity at a firm level, rather than at a country level (Hymer, 1960).

Furthermore, Hymer's theory suggests several main motives to conduct FDI in order to gain monopolistic control through the organisation of production in host countries, such as the distribution of risk, uncertainty, improving profitability, the volatility of the currency rates and reducing competition (Hymer, 1960; Pitelis, 2016). In other words, Hymer referred to a situation in which two monopolistic national companies compete against each other under conditions of low transport costs and the existence of customs duties (Hennart, 2001; Hymer, 1960). In light of that, under this situation of competition, the prices decline and the profitability is low, while in a merger of two monopolistic national companies, the competition decreases, which allows increasing the prices, and thereby improving the profitability (Dunning & Rugman, 1985; Hennart, 2001; Hymer, 1960). It can be argued that Hymer justified horizontal mergers and acquisitions (M&As) between two rival monopolistic companies from two different countries in order to reduce competition (Rozen-Bakher, 2018b). In spite of the above, Hymer's theory ignores the possibility of carrying out FDI in a condition of competition without monopolies (Pitelis, 2016; Teece, 2006).

3.2 Product Life Cycle Theory

Raymond Vernon's article "International Investment and International Trade in the Product Cycle", presents a macroeconomic approach to explain the activity of MNEs (Vernon, 1966). This approach is based on the microeconomic theory of the Product Life Cycle (Vernon, 1966). In the product life cycle theory, Vernon attempted to answer the question: Where products should be produced to maximise profit? (Vernon, 1966). According to Vernon's theory, the answer lies in the location of production that depends on the product life cycle. 

In view of the above, Vernon argued that products have a limited lifespan, and each product has a life cycle that consists of four main stages: introduction, growth, maturity and decline (Anderson & Zeithaml, 1984; Day, 1981; Rink & Swan, 1979; Vernon, 1966). Hence, the relocation of production to host countries is conducted according to the product life cycle (Day, 1981; Dunning & Lundan, 2008; Vernon, 1966), as discussed below.

·      Introduction Stage. In the introduction stage, the product is gradually presented to the market. During this stage, the product enters the market after the R&D completion process, and thereby, the demand for the product increases slowly. This stage is characterised by low competition, so the sale is based on product uniqueness, rather than on price. Thus, the revenue is low, but the profit margin is high. In addition, at this stage, the production is carried out in small quantities by highly skilled workers because the product has not yet completed its standardisation procedure. Therefore, production costs are still high. In light of that, from the international production standpoint, products are produced in developed home countries at this stage, while mainly are exported to developing host countries.

·      Growth Stage. During the growth stage, products are rapidly getting into the market and occurs a substantial increase in demand. During this stage, prices begin to decline due to increased competition, and as a result, the profit margin starts to fall. The quantity of the production increases and the production becomes standard, but the production costs are still high. Hence, from the international production perspective, during the growth stage, the product is produced mainly in developed countries, but the increase in demand for the product leads to relocation of production to developing countries in order to reduce the production costs. Besides, in this stage, the product enters new markets in host countries.

·      Maturity Stage. During the maturity stage, the demand is stable. However, in developed countries, there is a decline in demand, while in developing countries, the demand increases. During this stage, the competition is intense, and sales are based mainly on prices, so the profitability decreases. Given that, international production is carried out mainly in countries where manufacturing costs are low. Besides, the production is performed in large quantities (mass-production) by semi-skilled labour, and high standardisation of production is created.

·      Decline Stage. During the Decline stage, there is a significant decline in demand, and profits are very low. The number of competitors is small, but the sale is based solely on price, and the production is based on unskilled labour. Thus, the demand remains mostly in developing countries. Considering that, international production is carried out mainly in developing countries where manufacturing costs are very low. Nevertheless, developing countries begin to export their production to other developing countries.

Vernon's theory was written in the 1960s before the Internet era and the rapid technological changes that dramatically shortened the life cycle of technological products. That's led to a changing in the implementation of the product life cycle theory (Klepper, 1996), especially in relation to international production, and in particular, with regard to technological products with a shorter life cycle. In other words, each product has a different life cycle, which affects the period of each stage, and as a result, it also affects the place of production (Bilir, 2014). Hence, in cases of products with a very short life cycle, the period of each stage is also shortened, and thereby it influences international production. For example, smartphones are characterised by a short life cycle, so the period of each stage of its product life cycle is short too. Accordingly, it also influences the location of international production dramatically at each stage of the life cycle. It can be argued that a product with a short life cycle (e.g. Smartphone) is usually produced in the first place in developing countries, rather than in developed countries. That's done to achieve immediately lower production costs. More importantly, a combination of a product with a short life cycle along with an extensive production volume during the introduction stage like the case of the Smartphone reflects a situation in which the product quickly reaches the maturity stage. Notably, Vernon's theory was written under the assumption that a typical product life cycle is at least five years. Based on this assumption, even the calculation of depreciation in leasing transactions for purchasing products is also based usually on five years, particularly in the second half of the 20th century. However, the technological progress in the 21st century has led to a dramatic shortening of the product life cycle, even to the point of a few months, especially regarding innovative technological products, such as software and web applications. That's affected the location of the international production dramatically, especially in cases that a product needs mass production immediately from the introduction stage. Hence, Vernon's theory is still valid for products with a 'normal' product life cycle of at least five years. However, if a product has a short life cycle alongside the need for mass production when the product is released, then the introduction stage and growth stage are merging and shortening. However, after these stages, the product quickly proceeds to the maturity stage, and it's remained in this stage for most of its life cycle until it moves to the decline stage for a fast end.

4.      General Theories of MNEs' Activity

The early theories of MNEs provided new perspectives about the MNEs' activity, yet these theories didn't provide a full explanation of the various activities of MNEs. It also not explains the situation when MNEs operate under an open competition, rather than under a monopoly condition as suggested by Hymer. In the light of that, from the mid-1970s to the mid-1980s, several researchers attempted to develop a general theory to give a full explanation about the various activities of MNEs.

4.1 Internalisation Theory

Internalisation Theory was developed in the mid-1970s simultaneously by several researchers, including Buckley and Casson from the UK (Buckley & Casson, 1976), Hennart from the USA (Hennart, 1977), McManus from Canada (McManus, 1972) and more (Dunning & Lundan, 2008; Hennart, 2001; Narula & Verbeke, 2015). Notably, the Internalisation theory was developed simultaneously with the economic theory of "Transaction Cost Theory" (Narula & Verbeke, 2015; Williamson, 1975). However, in contrast to the common view, the internalisation theory significantly differs from Williamson's Transaction cost theory (Hennart, 2001) in terms of the unit of analysis. In the Transaction cost theory, the unit of analysis is a transaction, while in Internalisation theory, the unit of analysis is a company (Teece, 1986).

Buckley & Casson (1976) developed the Internalisation Theory, based on three fundamental assumptions. Firstly, companies maximise their profits in a market that their conditions are not perfect. Secondly, in a market where its conditions are not perfect, and middlemen exist, then there is an incentive to bypass the middlemen. It's done by creating markets without middlemen to allow companies to achieve control and ownership of their activities. Thirdly, if a market operates without middlemen in different countries, then it leads to the creation of MNEs (Henisz, 2003). In other words, MNEs choose to conduct FDI when the cost of transactions through middlemen is high. MNEs prefer to establish or purchase activities in host countries that are controlled and owned by the firms to save costs. Hence, Internalisation theory attempts to predict in which situations it would be more worthwhile for an MNE to establish or purchase activities in host countries, rather than to export their products to host countries. Notably, many factors may affect MNEs' entry mode decisions, such as technology, the ability to monitor the product quality, and government regulations in host countries (Dunning & Lundan, 2008).

4.2 Eclectic Paradigm: Ownership, Location and Internalisation (OLI) Framework

In the early 1980s, John Dunning published the Ownership, Location and Internalisation (OLI) theoretical framework in order to explain the international production conduct by MNEs through the entry mode of FDI (Dunning, 1980, 1981). In the following years, Dunning published additional articles and books that explained, extended, improved and re-evaluated the OLI theoretical framework (Dunning, 1988a, 1988b, 1993, 1995, 1998, 2000, 2015; Dunning & Lundan, 2008), which has made the OLI framework to one of the leading theories of MNEs. Notably, the Eclectic paradigm is a theory that focuses on MNE's activity through FDI, rather than a theory that addresses the various entry modes of MNEs' activities. More importantly, Dunning's theory is a positive/ descriptive theory (Bell, 1988; Dunning & Lundan, 2008; Jones & Neary, 1984; Williams, 1997), rather than a normative/prescriptive theory (Bell, 1988; Corden, 1984), and thereby it seeks to present the MNE activity in practice without trying to guide how the MNEs should operate. Furthermore, the Eclectic paradigm stems from the macroeconomic theory of international trade alongside the microeconomic theory of the company. Therefore, it enables analysing at the company level alongside at the country level. It differs from the internalisation theory that enables analysing at the product level alongside at the company level but without the ability to analyse the country level (Dunning & Lundan, 2008).

In light of the above, the OLI theoretical framework was developed with the aim of explaining − Why MNEs operate? Where MNEs conduct FDI? And How MNEs operate in host countries? − in order to obtain resources, new market, efficiency and strategic assets (Dunning 1995, 1998, 2000, 2015; Dunning & Lundan, 2008), as discussed below.

Ownership Advantages - Why? The ownership advantages of a company derive from the company's characteristics, assets and strategy, which shape the company's advantages relative to its competitors. Firstly, the characteristics of a company are related to various factors, such as the company's size and sector. Secondly, the company's assets refer to the tangible assets such as real estate, workforce and capital, alongside the intangible assets such as knowledge, patents, product's innovation, firm's capabilities (e.g. Marketing, service and management) and the firm's ability to operate in an efficient way (Cooke & Noble, 1998; Dunning & Lundan, 2008; Lundan, 2010). Thirdly, the company's strategy stems from the management's decisions in order to achieve the company's goals at a specified time. Moreover, each company has a unique strategy that highlights the differences between companies in terms of management, organisational structure, risk attitude, knowledge transfer, entry mode and more (Dunning 1981, 1988b; Dunning & Lundan, 2008).  Hence, the ownership advantages of a company determine the company's ability to engage in FDI, and thereby it increases the company's competitive advantages (Dunning & Lundan, 2008; Lundan, 2010; Williamson & Wan, 2018).

Location Advantages - Where? The location advantages of a country stem from the country's characteristics that are available to all companies who operate within the country. The location advantages of a country refer to the country's natural and production resources, such as the workforce, raw materials and energy, alongside the country's infrastructure in terms of cost, quality and productivity, such as the transportation and communication infrastructure (Wekesa et al., 2016; Wilson & Baack, 2012). The location advantages of a country also refer to the government policy regarding international trade and FDI, such as incentives, barriers and tariffs, as well as to additional country factors such as education, technological capabilities, national culture, political arena, economic system, laws (e.g. Property rights), and even to the existence of supporting industries in a country, such as industrial parks (Dunning & Lundan, 2008; Wilson & Baack, 2012). The location advantages of a host country affect the scope and types of FDI inward (Dunning & Lundan, 2008; Dunning, 1981, 1988b). However, the location advantages of a home country affect the scope and types of FDI outward (Dunning & Lundan, 2008; Dunning, 1981, 1988b).

Internalisation Advantages - How? Internalisation advantages in a country refer to the power struggle between the government and MNEs in a country regarding their mutual attempt to maintain the political power over their assets (Dunning & Lundan, 2008). Nevertheless, sometimes, these attempts are carried out in a conflicting way, which influences the activities of MNEs in the country (Dunning & Lundan, 2008). Hence, the internalisation advantages refer to two different viewpoints: the viewpoint of the company and the viewpoint of the country.

In light of that, the internalisation advantages of a company stem from the company's internal hierarchical structure, which reflects the hierarchical efficiency of the organisation in relation to the market's hierarchy. It also stems from the ability of a company to maintain its political power over its assets in host countries where the company operates. Besides, the internalisation advantages of a company are derived from the company's characterises. This affects the company's ability to bypass structural market failures in a country or to exploit them for the sake of the company's interests. It occurs particularly when market failures arise due to the inability of the market to arrange transactions in an effective way (Li & Resnick, 2003). It is based on the argument that companies who operate in a market haven't complete and symmetrical information about their transactions in the market. They haven't also an understanding and full confidence regarding the implications of conducting transactions in the market. As a result, it increases the opportunism, moral risks and exploitation of the lack of information in certain markets. According to this rationale, companies attempt to avoid various transaction costs, such as negotiation costs (Pheng & Hongbin, 2006), violation of agreements and administration costs (Williamson, 1985). Moreover, companies attempt to bypass government regulations, such as tariffs, price control, taxes, suppliers' control and limitation regards competition. 

Furthermore, MNEs act to protect their reputations in host countries by taking advantage of uncertainty in the market. Hence, the internalisation advantages of a company affect the entry modes in terms of MNEs' control of its activities in host countries. That's reflected in the MNEs' ability to operate independently in host countries through FDI over transferring their control to local parties in host countries through licenses and franchising (Dunning & Lundan, 2008; Dunning, 1981, 1988b). However, the internalisation advantages of a country refer to the extent of the government's involvement in the market through regulations, as well as to the government's policy regarding the market structure, anti-competition law, deals limitations (e.g. M&As, takeovers) and more. Hence, governments can implement policies to maintain the country's political power and national strategic assets at the expense of economic openness and liberalisation. On the contrary, governments can implement policies to encourage FDI through the elimination of monopolies and the removal of restrictions (Dunning & Lundan, 2008).

4.3 Porter's Diamond Model

Michael Porter, in his book "The Competitive Advantages of Nations, 1990", developed the Diamond Model under the influence of several theories, such as Adam Smith's Absolute Advantage Theory, Heckscher Ohlin's Factor Proportions Theory and Vernon's Product Life Cycle Theory (Daniels & Radebauge, 2002). Porter's theory attempts to answer the questions: What factors in a country affect the success of a country in international trade in specific sectors? And how do these factors affect the competitive advantage of companies who operate in the country? (Porter, 1990, 2008). In other words, Porter's theory attempts to answer the questions of how and in which countries, companies develop a globally competitive advantage. Hence, Porter's theory tries to explain international trade from the company perspective in contrast to the classical international trade theories that analyse it from the country perspective (Daniels & Radebauge, 2002; Porter, 1990).

According to the Porter's 'Diamond Model', four conditions are required at the country level and at the company level to achieve globally competitive advantages by the local companies: factor conditions, demand conditions, related and supporting industries, and firm strategy, structure and rivalry (Chobanyan & Leigh, 2006; Grant, 1991; Porter, 1990, 2008; Wonglimpiyarat, 2018), as follows:

Factor Conditions. The first condition refers to the factor conditions in a certain sector in a country, especially with regards to the conditions of the production resources. More specifically, this condition refers to physical resources, such as natural resources and raw materials, as well as to advanced resources, such as high-quality infrastructure (Wekesa et al., 2016), advanced technologies and skilled labour. According to Porter, the development of advanced resources may offset the lack of physical resources in a country.

Demand Conditions. The second condition refers to demand conditions of a market in a country, with an emphasis on market characteristics rather than on market size. According to Porter, a local market with high-demand conditions is supposed to lead to an improvement in the company's efficiency. That should help the local companies to be more competitive in the global markets. In other words, a local market with high-demand conditions helps to improve the global competitive advantages of the local companies who operate in the global markets. Moreover, according to the 'Diamond Model', there is a difference between high consumption and appropriate demand conditions. That may explain the difference between monopolistic markets and competitive markets in relation to high consumption. High consumption in monopolistic markets does not lead to a situation in which companies improve and become more efficient due to the lack of competitiveness. However, high consumption in competitive markets is supposed to improve the demand conditions. Therefore, a high consumption along with a lack of competition in the home market can dramatically hinder the competitive advantages of a company and its ability to compete in global markets. In light of that, only appropriate demand conditions alongside competitiveness in a market can lead to a situation in which companies are required to improve and become more efficient. That may contribute to the company's global competitive advantages and its ability to successfully engage in export and FDI outward.

Related and Supporting Industries. The third condition refers to the existence of related and supporting industries in a country to help with the development of local companies who operate in the same sector in which the related and supporting industries exist. That may contribute to the knowledge transfer, innovation and resources in those sectors in which related and supporting industries exist. For example, local service providers and consulting firms that operate in the same sector may contribute to a knowledge transfer. This condition explains the creation of certain areas of expertise in each country, such as the ceramic industry in Italy, the watch industry in Switzerland, and the high-tech industry in Israel. In other words, the monopolistic approach suggests that a small number of competitors may lead to sector success in terms of lack of competition. By contrast, Porter believes that many competitors that operate in a particular sector may lead to a success of the sector due to cooperation, knowledge transfer and mobility of employees between the local firms. 

Firm Strategy, Structure and Rivalry. The fourth condition refers to the firm's strategy, structure and rivalry in which the firm operates in a certain sector in a country. This condition refers to the MNE's structure and strategy, which allow the MNE to manage international activity in competitive foreign markets successfully. In other words, this condition reflects the managerial skills that exist in a company, which enables the company to manage activities in global markets under conditions of international competition.

Hence, according to the 'Diamond Model', companies could begin to engage in international trade only if the conditions in their home country allow them to become competitive firms in foreign markets (Porter, 1990).

5.      Conclusions

This study explores the main theories of MNEs that have evolved over the last centuries, either those who explain the international trade or FDI, still, from the perspective of the 21st century to understand if these theories still explain the current reality of MNEs activities. The study examined the following theories: Mercantilism, Absolute Advantage, Comparative Advantage, Factor Proportions, Hymer’s Contribution, Product Life Cycle, Internalization, Eclectic Paradigm, and Diamond Model. The study suggests that most of MNEs’ theories still explain the reality in the 21st century. Mercantilism has become recently an important economic tool to protect jobs and nationalism agenda by maximising export over import via new restrictions on international trade and FDI, resulting in trade wars. On the contrary, the Comparative Advantages Theory has been adopted by World Trade Organization (WTO) to advance the liberalization in international trade and FDI via elimination of restrictions. However, Absolute Advantage Theory and Hymer’s Contribution may not explain the reality today because they reflect concepts and market conditions that rarely exist today. Nevertheless, Vernon’s theory may be adjusted to the complex reality of MNEs, yet under the concept of a short Product Life Cycle. Finally, the theories of Dunning and Porter could be used as important theories to explain the complexity of the current activities of MNEs, either when they conduce international trade or FDI.

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