From United Nations University
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4. The determinants of TNC activity
5. Modern theories of TNC activity
6. The theory of joint ventures and cooperative agreements
7. Towards a general paradigm of international production
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4. The determinants of TNC activity
4.1 International production as an extension of an enterprise activities
a) the concept of the value added chain
b) the main forms of growth
i) expand existing activities by acquisition, merger or coalition
ii) diversify existing activities along value added chain (vertical
integration) or across value added chains (horizontal or
lateral diversification)
iii) diversify into new markets
Each of the above options may or may not involve an international
dimension
c) the choice of FDI as mode of expansion cf. e.g. exports, and
licensing, and collaborative agreements
4.2 Reasons for and types of foreign production
The basic objective is to protect and advance the long term
commercial interests of the TNC. Success is usually measured in
terms of economic power growth, profitability and market share,
but in the short-run, at least, other indices e.g. liquidity,
a balanced portfolio of foreign assets etc. may be no less
important. Moreover there are various types of international
production, each of which will be prompted and determined by
different factors.
a) Motives for initial investment
i) to seek new, or protect existing markets: import substituting
investment
ii) to seek new, or protect existing supply of resources: export
oriented investment
- natural resources (in primary activities)
- labour (in manufacturing and service activities)
- technology and information (Third World involvement in
developed countries)
iii) to seek new, or protect existing competitive advantages
b) Motives for investment expansion
i) rationalised investment: exploiting the international
division of labour by product or process specialisation
to advance the global goals of TNCs
- benefits arise from integration of complementary value
adding activities and sharing of overheads; e.g. economies
of scope
- economies of scale and specialisation of output, based on
distribution of factor endowments
- the gains, e.g. improved learning capabilities from the
geographical diversification of production and transactions
- relationship of rationalized investment to market oriented
and resource based investment
- the need to have a presence in the leading markets of the
world; the concept of 'triad' power
ii) vertical and horizontal integration (internalisation) by
foreign affiliates
c) Other reasons for foreign production
i) acquire new markets for investing firms
ii) make capital gain or profits on assets acquired at favourable
prices
iii) as an oligopolistic and/or risk reducing strategy (inherent
in much of a) and b))
iv) to diversify asset portfolios
v) to extend market power
4.3 The determinants of FDI and international production
a) the multiplicity of issues: distinguish among the WHY, the
WHERE, WHEN, and the HOW of foreign production
b) the distinction between foreign investment, foreign direct
investment and the TNC as an institution which organizes and
controls value adding activities in foreign countries
i) pre 1960 theoretical view of FDI as branch of international
capital movements
ii) pre 1960 empirical research viewed determinants as extensions
of locational economics
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Rugman, Lecraw and Booth(1985) Dicken(1986)
See Bibliography
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5. Modern theories of TNC activity
5.1 The 1960s: development of new "partial" and more micro-economic
oriented theories
a) the industrial organisation theory market power approaches
(Hymer 1960/1970), Kindleberger (1969): Why TNCs? How is it
possible for foreign firms to compete alongside domestic
firms?
b) the location theory approach: Where do TNCs invest?
c) theoretical shortcomings of above approaches; the Product Cycle
theory (Vernon, 1966, Wells 1972) - Why, where and how do TNCs
invest
5.2 Theoretical advances in the 1970s
a) extensions of industrial organisation approach: identifying and
evaluating the firm/ownership specific advantages that explain
patterns of FDI
i) superior quality of management
ii) innovative capacity
iii) product differentiation
b) extensions of financial theories
i) explaining FDI 'per se' - not international production:
imperfections of capital and foreign exchange markets:
the Aliber approach
ii) explaining the composition of TNCs' foreign activities:
portfolio theory
c) the strategy of TNCs: a behavioural approach - oligopolistic
strategy to preserve markets or forestall competitors;
extensions to the market power approach
d) extensions of theory of the firm: these focus on the TNC an
institution which coordinates complementary value activities
across national boundaries
i) why firms engage in international production: market failure
to transact exchange of intermediate products efficiently
- high costs of negotiation and transactions
- to lessen the risk of supply disruptions or price hikes
- to protect proprietary rights against abuse
- absence of future markets
- inability to capture full economic rent on proprietary rights
- to ensure quality consistency
- to protect markets against competitors
- to exploit economies of common governance (i.e., those
which are external to any one of several value added, but
are internal to the firm undertaking them all)
ii) how firms seek to exploit advantages over (a) markets and
(b) competitors
- the degree of equity ownership: joint ventures; the
distinction between "ownership" and "control"
- the choice between equity investment and trade
- the choice between equity and non equity participation
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Dunning(1973,1988) Hood and Young(1979)
Grieco in Moran(1987) Jenkins(1988)
Newfarmer(1985)
Cowling and Sudgen(1987) -the authors examine TNC as the main economic
agent of transnational monopoly capitalism
See Bibliography
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6. The theory of joint ventures and cooperative agreements
6.1 The nature of markets and firms
a) the spectrum of organising transactional relations between markets
and firms; the distinctive characteristics of firms
b) a review of the types of association between independent firms
- cooperative or competitive arrangements?
c) the nature of markets for intermediate products; e.g. technology,
management skills etc.
6.2 Issues relating to any form of alliance
a) Is equity capital involved? (cf. a joint equity with a non-equity
alliance)
b) Composition of parties to the alliance: e.g. inter-firm, firm/
government, consortia of firms, mixed
c) pattern of financing e.g. debt/equity ratio
d) distribution of equity ownership; is it majority, 50/50, or
minority foreign owned? Is equity evenly or unevenly divided
among investors? What is the balance between the distribution
of preference cf. ordinary shares?
e) terms of agreement; methods for acquiring equity, declaration
of risks and liabilities such as future capital requirements,
voting rights, loan guarantees, obligations following dissolution
f) control and management issues e.g. composition of Board of
Directors, appointment of C.E.O., disclosure of information, etc.
g) division of operational rights and responsibilities e.g. with
respect to different functions along value added chain
h) how does an alliance fit in the TNCs international strategy?
i) distribution of financial and non financial benefits; and
restrictions on use of shared inputs or output
j) can alliances assist TNC in its dealings with local firms,
government, labour unions etc.?
NOTE: the main reason why joint ventures fail is that the above and
similar issues have not been agreed upon prior to the formation
of the agreement; and/or because of differences in objectives,
expectations and managerial ethos and strategies
6.3 Reasons for TNCs to prefer non-equity alliances
a) INTERNAL TO THE FIRM
i) as an initial penetration of a foreign market
ii) to avoid capital risks associated with equity involvement
iii) where goals of TNC are primarily to appropriate economic rent
on a particular asset rather than capture the economies of
interdependent activities
iv) where knowledge et al competitive advantages are easily
codifiable
v) where need for association with another firm is likely to be
temporary, and/or it is intended to serve a very specific
purpose (e.g. a production agreement for a single product)
vi) as part of a reciprocal licensing arrangements
b) EXTERNAL TO THE FIRM
i) where markets for intermediate products functions satisfactorily
i.e. contractual and market clearing costs are low
ii) where government fiat disallows FDI
BUT note licensing may abrogate TNCs rights to export particular
markets and may help create competition in third markets
6.4 The issues of control; the concept of contract or quasi-
internalisation; the dynamics of resource transfer (see e.g.
the industry technology cycle (Magee 1977)
6.5 The choice of particular modalities of non-equity involvement
preferred
a) as determined by
i) the particular type or age of asset being transferred cf.
management contracts with technical service agreements
ii) the raison d'etre for the involvement
iii) the timing of the involvement (Davidson and McFeteridge
(1985))
b) the extent to which the required "control" over resource
allocation and the distribution of economic rents can be built
into a contract (e.g., cf. subcontracting with backward vertical
integration)
c) the extent to which a contract is part of a wider group of
contracts (e.g. as in case of co-production and/or complementation
agreements)
d) the extent to which a continuing relationship between the
contractor or contractee is required e.g. cf. turnkey contracts
with technical assistance agreements
6.6 Why might joint ventures be preferred as an intermediate
organisational route for TNCs
a) economies of synergy between partners
b) easier, quicker or less expensive route by entry into new markets
c) lower capital involvement
d) joint ventures might be used as a 'guinea pig' by foreign company
e) diversification of risks
f) sometimes joint ventures are the only route of investment allowed
by host governments
g) joint ventures in developing countries: some empirical evidence
6.7 Strategic alliances as a form of collaboration agreement
a) types of sectors (high technology, capital or information
intensive)
b) likely partners
c) types of alliances - vertical, horizontal, lateral, etc.; across
and along value added chains
d) reasons for inter-firm agreements
e) determinants of success or failure of alliances
f) a cost-benefit analysis for choosing between fully-owned
investments and cooperative relationships
6.8 The costs and benefits of joint ventures from the perspective of
host developing countries
a) the need for an appropriate macro-economic policy
b) the need for an adequate indigeneous collectional, technological
and entrepreneurial infrastructure; and macro-economic strategy
c) the need for full information about the respective contributions
(or potential contribution) of TNCs and their local partners,
and of the distribution (or likely distribution) of the benefits
of joint ventures
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Robinson(1978) Casson(1979)
Telesio(1979) Oman(1984)
Contractor(1981)(1986)
Svejnar and Smith(1984)
See Bibliography
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7. Towards a general paradigm of international production
7.1 Introduction
There have been two main attempts to synthesise and unify the
various theories of international production, and, by default,
non-equity resource transfer viz. the internalisation and eclectic
paradigms. In addition, a more macro-economic, trade related and
normative explanation has been offered by Kojima(1978)
7.2 Internalisation
a) in this paradigm, international production reflects the
willingness and ability of firms to internalise intermediate
product markets across national boundaries. FDI is the mechanism
by which TNCs maintain their control over the organisation of
value-adding activities in a foreign country
b) the internalisation model purports to explain the very existence
of TNCs, in terms of the failure of markets to efficiently
transfer intermediate products between independent buyers and
sellers located in different countries. It is, in this sense,
a general theory of the TNC. Buckley and Casson(1985), Rugman(1986).
But it has also been used to explain particular aspects of the
decision process by TNCs. In particular the FDI vs. export
decision is explained by the costs and benefits of internalising
market distorsions (e.g. tariff barriers) over space, and the
FDI vs. licensing decision in terms of the costs and benefits
of internalising international transaction costs of particular
assets
7.3 The eclectic or OLI paradigm: the why, where and how of international
production
a) an analytic framework for pinpointing the determinants of
foreign production and TNC activity, vis-a-vis both trade
and licensing, and embracing elements of industrial organisation,
trade, and locational theory
b) The OLI triumvirate; the three conditions leading for a firm
to engage in FDI or to increase its FDI
i) competitive or OWNERSHIP (O) advantages, vis-a-vis firms of
other nationalities serving the markets it seeks to serve:
these advantages are of two kinds
- the privileged possession, or access, to specific assets
(e.g. technology, management skills, etc) and
- the opportunity and ability to coordinate these assets
accross national boundaries
ii) superior benefits from INTERNALISING the markets or use of
these advantages rather than licensing them to independent
foreign firms ( I advantages)
iii) benefits from using O advantages and I advantages in
conjuction with at least some resources located in a
foreign country ( L advantages)
c) The eclectic paradigm and developments in TNC activity during
the 1970s, 1980s and 90s
i) the industrial and geographical composition of FDI
ii) the trend towards joint ventures and non-equity agreements
in some sectors; and towards 100% owned affiliates in others
iii) the emergence of outward direct investment by developing
countries
iv) the growth of export platform type investment
v) the growing multinationalisation of many industrial sectors
and the burgeoning of intra-industry (cross hauling) FDI
(paralleling that of intra-industry trade)
vi) comparisons in the structure of ownership on TNCs in Africa,
Latin America, Asia and the Pacific and China
vii) the globalisation of production and markets; the formation
of function-specific strategic alliances
viii) the increasing propensity for TNCs to divest some of their
activities
d) the dynamics of the OLI paradigm: how and why the OLI
configuration may change over time; the applicability of the
investment development path or cycle (Dunning 1981, 1988) to
explaining the changing international investment position of
developing economies; strategic behaviour as a response to
OLI advantages in time 't' while affecting the value and
configuration of OLI advantages in time 't+1'
e) the inter-disciplinary nature of the eclectic paradigm. The
main differences between the two approaches just described
is that the former concentrates on explaining the institutional
modality by which resources are transferred across national
boundaries (i.e. why and when TNCs trade intermediate products
internally rather than make use of external markets) while the
eclectic paradigm is also interested in why TNCs can out-compete
uninational firms (i.e. why TNCs grow relative to other firms).
Moreover, the eclectic paradigm asserts that firms and markets do not
perform identical functions; only firms engage in value adding
activities. In consequence, it does not accept that the FDI vs. export
or licensing decision is always determined by market failure
considerations. Observe too that while both paradigms offer a framework
for explaining all kinds of international production, the relevant
internalisation/OLI variables will depend on the particular type of
international production one is seeking to explain (see 4.2). Finally
to explain or predict the behaviour of particular TNCs or groups of
TNCs both paradigms need to be supplemented by an appreciation of firm
specific strategic-related variables. It is here where the business
strategy/policy literature is especifically helpful. For an evaluation
of the main strategic considerations affecting the globalisation of
firms see Porter(1986), Ghoshal(1987) and Barlett and Ghoshal(1989)
7.4 The Kojima approach (Kojima 1978, 1982, Kojima and Ozawa 1984)
a) both the internalisation and eclectic paradigms purport to
explain the extent to which one country's firms engages in
production outside their national boundaries; but they do so
not from a macro-economic or normative viewpoint. They ask
the question "why do firms or countries engage in or expand,
international production" rather than "what is the best
allocation of economic activity undertaken by firms of
different nationality of ownership within a country (including
the generation of O advantages which might be exploited by its
own firms in other countries")?
b) Kojima is more interested in the second question: he argues that
the propensity of countries to engage in FDI is dependent on:
i) the comparative advantage of investing, exporting and
importing countries of particular resource endowments
ii) the market structure within which TNCs operate
c) Kojima further alleges that Japanese TNC activity is trade
creating while US TNC activity is trade substituting. The
evidence no longer supports this contention. He also asserts
that Japanese investment in developing countries plays a
greater 'tutorial' role than does that from Western countries.
Note the eclectic paradigm may also be used to suggest an
"optimal" policy towards inward and outward FDI. For contrasting
views of the eclectic (and internalisation) and Kojima approach
see Kojima(1982), Buckley(1983a) and Kojima and Ozawa(1984).
For other attempts to present integrated theories of trade,
production and foreign direct investment see Gray and Casson
in Black and Dunning(1982).
7.5 The theory of foreign direct investment (or disinvestment).
Voluntary divestment by TNCs should be regarded as an on-going
process and part of the restructuring of international production.
The phenomenon does, however, raise several interesting questions.
These include:
a) what is meant by disinvestment?
b) what are the forms of disinvestment e.g. involuntary and
voluntary, partial and total etc.
c) what are the reasons for disinvestment? e.g. failure or
restructuring
d) how does one explain disinvestment? Is it that the factors
which make for investment no longer apply? Is there a counterpart
to the eclectic paradigm of an increase in foreign production
to explaining a fall in production?
e) What is the evidence of disinvestment e.g. in which types of
sectors, in which countries, by which TNCs, over which time
period?
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Caves(1982) Dicken(1986) Rugman, Lecraw and Booth(1985)
Kojima(1978,1982)
See Bibliography
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RRojas Research Unit/1996
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