Multinationals and Foreign Direct Investment (FDI)
International markets have been promising after the war. The rise of open markets for goods as the result of GATT processes and later the globalization of markets for capital, and partly for services and labor, have been understood as a set of processes in economy, culture and society. Globalization as a concept has much in common with earlier concepts like internationalization. It was Professor Theodore Levitt at Harvard who first discussed global markets and global giants, multinational corporations (MNCs) or simply multinationals. It is worth noticing that parallel to globalization, there has been a shift in the comparative advantage of international trade away from traditional inputs of production, such as land, labor and capital, towards knowledge. The knowledge intensive or network intensive regions are the potential winners of the global agglomeration economies. The large home market countries, such as the U.S., are most frequently the host countries of MNC headquarters. The role of MNCs has been recognized to be important in present, intertwined global economy. The growth of the MNCs in number has been remarkable (table 1).
Year Number of MNCs
1969 7 000
1990 24 000
1995 37 000
1997 53 000
2001 60 000
Table 1: Number of MNCs in 1969-2001
Stephen Hymer's dissertation explicitly recognized the existence of firm-specific assets. In other words, FDI draws on the role of firms as creators and exploiters of intangible firm assets. It was highly popular in those days, particularly among the general public and the political science discipline, to “see MNCs as big and bad”. Hymer was not an exception. He saw MNCs as taking advantage of barriers to entry to earn monopoly profits. Today, MNCs are embedded in practically in all contemporary capitalist societies, the most powerful actors of the Schumpeterian trustified capitalism. John Kenneth Galbraight, referring to the U.S., wrote that MNCs are the continuation of a country’s power system on an international level. Peter Buckley, Mark Casson, and John Dunning are among the writers that developed a more analytical theory that argued that MNCs exist to complement the supply of markets. In the macro level, Alan Rugman has written extensively on MNCs and government policy, particularly trade and FDI policy. Alan Rugman believes that MNCs are inherently increasing world welfare and are not exploitative. Government regulations of their behavior are likely to reduce overall welfare gains, since they prevents MNCs from doing what they do best (internalizing markets).
The global markets are dominated by MNCs. The logical consequence of that is to reject the neoclassical assumption of perfect competition. Referring to the IO theory, the existence of MNCs engaged in FDI can be explained by market imperfection that are resulted from factors like proprietary technology, scale economies, control of distribution systems, and product differentiation.Through their decisions, MNCs themselves restructure the markets and the rules of the game. What MNCs are doing is dependent on the oligopolistic nature of competition in terms of Chamberlin. Even in a global oligopoly, firms are interdependent. They enter a market as a chain action of others. Firms go abroad to follow their competitors, customers or partners. Instead of neoclassical assumptions, the relevant indicator of the market efficiency is contestability. One of the major problems in that sense is the “newborn” mercantilism that at least partly is reflected by the clustering boom. Contestability is especially difficult to maintain in industries where major firm’s production function is based on country-specific matters or where there are essential governmental regulations or barriers of trade. MNCs are dominant players in the global markets. Markets are contestable, if they are open for new entrants. In other words, this can be interpreted that competition in the market is working, not perfectly, but adequate enough to give consumers new, genuine alternatives.
MNCs take advantage of the homogenous consumer segments in the global markets. This increasing similarity or homogenization of tastes leads Levitt to conclude that there are global markets for some products and services. Serving the global market segments with standardized products or services offers valuable economies of scale and scope for MNCs. The fact that MNCs can have a major impact on the restructuring of consumer segments globally has lead to an assumption that oligopolistic rivalry provides MNCs a chance to empire-building at the global level. One of the major reasons behind such an assumption is that MNCs, through strategic entry deterrence, build-up overseas capacities in order to stop potential rivals from entering the most potential market segments. The worldwide economic growth rate is relatively low, especially in the developed countries. MNCs have competitive pressures to win market shares from local competitors, which is an explanation to FDIs in relatively mature markets. In the growth markets, MNCs attempt alternatively to reestablish market power through strategic alliances, joint ventures and collaboration over R&D. MNCs are the dominant actors of the multi-cultural supply of global commodities. Globalization has had a fundamental effect on shifts in demand from local to global. Customer tastes around the world are becoming more similar. In some product markets, MNCs attempt to improve their market share to reach an oligopolistic equilibrium, a market leadership. MNCs make portfolio investments abroad to increase and obtain control of some critical resources.
According to Nagesh Kumar, FDIs’ contribution to the host country’s GNP growth is more than proportionately compared to domestic investments, because of knowledge and technology spillovers to domestic firms from MNCs. The externalities, such as spillovers, may not take place in some cases because of poor absorptive capacity of domestic firms. MNC’s entry may affect domestic firms adversely given the market power of their proprietary assets such as superior technology, brands and aggressive marketing. The effects of FDIs on domestic investment and growth are dynamic in nature. Because of superior assets of MNCs, domestic firms may loose their market share in the short run. In the long run, domestic firms may absorb spillovers of knowledge through vertical or network linkages. Economic globalization means that economic actors in firms and public sector have a challenge to develop their abilities to genuinely operate at the global level.
The openness of markets is one of the key questions for increasing welfare and industrial dynamism in the transition and developing countries. Terutaka Ozawa emphasizes the remarkable effect that foreign investment has on economic growth through increase in trade. Ozawa believes that the patterns and directions of inflows and outflows of foreign capital change in conjunction with the stages of structural transformations in the economy. Inward FDI is typical for the first, factor-driven stage when seeking for cheap sources of raw materials and lower labour costs compared to home countries. The existence of MNCs brings market dynamics to be considered. The assumption of immobile factors of production is also no more valid for empirical purposes.
The growth of total capital invested into developing economies has been huge during the three decades of globalization. FDI is an important source of external resources and a significant part of capital formation, despite that their share in global distribution of FDI is declining. The majority of FDI still goes to the well developed countries, where wages are high relative to those in developing countries. We are in the midst of a global reallocation of production activities. China and India were the star performers in aggregate GDP growth in the 1980s and 1990s. The rush of Western firms to access these countries, with their enormous domestic market, seems to continue. What is surprising is the speed by which the local firms, especially Chinese firms, have developed their technologies and positioned themselves as potential competitors to producers in the EU and the U.S. Chinese firms have succeeded to turn the state control to their advantage by beating MNCs their home markets. Now these firms are launching their first export products to beat western MNCs globally. The vitality of the Chinese “Dragon” and the Indian “Tiger economy” has risen some concerns. What is the global economy like, if virtually all production competencies will disappear from developed countries and be taken on by eager producers in China and India. The recent growth in MNCs and FDI in the world economy is explained by global factors, specifically liberalization.
In the 1960s and 1970s, economists explained MNCs through their FDI location patterns. Peter Buckley and Mark Casson  were the first who called attention to advantages which may accrue to a firm from internationalization, i.e. engaging in foreign production itself. The essence of internationalization theory are market imperfections that may arise as the result of exogenous variables (externalities) in the goods or factor markets. These externalities can take the form of government induced regulations and control actions. There is, of course, the continous risk of market failure in the foreign operations, because of the lack of relevant information or knowledge (natural externalities). MNCs attempt to overcome these negative externalities by internalizing is operations. Thereby, MNCs are able to maintain control over their international operations outside their national boundaries.
The theory of internationalization drew on the transactions costs theory which provides a rationale to explain why it may be advantageous to concentrate certain international operations within the firm, rather than rely on the market mechanism. Marks Casson believes that in order to explain the existence of the MNCs it is necessary to include transaction cost theory. In the global context, markets are far from being perfectly competitive, and, therefore, the market operations are not costless. There are transactions costs of many kinds. Such costs include seeking buyers and sellers, and costs involved in negotiating, co-coordinating, monitoring, and enforcing contracts. When it is cheaper for a firm to undertake transactions internally, rather than via the market mechanism, internationalization which is engaged in the foreign production will be preferred. When the market does not exist, firms internalize transactions and become organizing units that supplants the price mechanism. One major source of transaction costs is the tacit nature of firm specific knowledge. When tacitness is high external market mechanisms become unsuitable to transfer intangibles assets such as knowledge.
The essence of internationalization for the MNCs is not that it explains the existence of the firm (transaction cost theory), but that it explains MNCs’ multi-plant operations over space (Casson, 1982). Internationalizing the market mechanism because of transaction costs is not a unique idea. Based on his analysis of the industrial history of Western countries from the 1880s to the 1980s, Alfred Chandler proposes the concept of economies of speed. Chandler’s concept of economies of speed has much in common with the transactions costs theory. In Chandler’s thinking, the idea of speed of throughput has been important in explaining the rise of the large, vertically integrated firms. Chandler emphasizes the role of these firms as the innovators of new technologies. These firms, nowadays MNCs, exploit the potential of economies of scale and scope made possible by the new technologies of production. The economies of scale depends on the size of capacity and speed (or the intensity) with which the capacity is utilized. Chandler focuses on a managerial process, not the costs of acquiring inputs like the writers of the transactions costs theory.
When Tom Peters published his book Thriving On Chaos in the end of 1980s, many felt his dramatic predictions of the fundamental changes facing U.S. firms were extreme. A decade later, it appears he may have underestimated both the intensity and complexity of those changes. Tom Peters refers to fragmented markets, and proposes a flexible specialization as a strategy, by which he means smaller economic units or firms providing a wider variety of products for narrower markets. Tom Peters declared it the time of uncertainty. It was not the first time. Both Joseph Schumpeter and John Kenneth Galbraith made the same declaration after the wartime. The Schumpeterian creative destruction has been going on since. One of the most devastating periods was in the end of 1920s and early 1930s, when the industrialized countries transferred from industrial to postindustrial society. Now, it is question of the revolution of information technology (IT) and globalization of economies. According to a modern interpretation of Chandler’s thinking, the reason why a firm decides to internalize its operations can be the threat of transaction costs because of tacitness of intangibles assets. In that case, a firm’s management is the Visible Hand, the powerful actor that internalizes the critical part of production. This is exactly what the Nokia management has done, for instance.
Internationalization and economies of speed are closely related to Schumpeterian-based production, which refers to fast-growing, innovative and know-how-based production. Interpreting Chandler’s concept, the first movers are often firms that through interrelated sets of investments in production, distribution, and management can achieve the competitive advantages of scale, scope or both. The global first movers, in terms of Chandler’s economies of scale and scope, are very often MNCs, although this is basically the core area of entrepreneurship. The critical managerial competence is MNCs’ ability to implement multi-plant operations globally. A counter power to MNCs’ excellence in internalizing of global markets is the so-called venture capital approach that centers on the exponential growth of innovative firms.
According to John Dunning, the IO theory failed to differentiate between structural (Bain, 1956) and transaction-type (Williamson, 1975) imperfections of markets. The transaction cost type imperfections are the main reason for MNEs to internationalize their markets. The potential cost savings provide the impetus for MNEs to expand their operations via internalization. Internationalization theory provides an explanation of the growth of the NMCs and gives insights into the reasons for FDIs. John Dunning establishes the eclectic theory according to which a firm possesses three advantages:
1. Ownership advantages are endogenous to the firm. According to Dunning, firms move their production abroad when they have certain ownership specific advantages over competitors. Ownership advantages primarily take the form of intangible assets, which are exclusive or specific to the firm possessing them. Globalization requires reappraisal, since a firm, reaching for ownership advantages, has to overcome barriers, which which do not confront local firms.
2. Location advantages which are external to a firm. There are extra costs for a firm investing in a foreign country related to the familiarity of local markets and institutions.
3. Internationalization advantages encourage a firm to internalize operations for production to replace the need to utilize markets. Internalization advantages result from exploiting market imperfections and internalizing them into firm advantages. Internationalization theory is thus very closely related to transaction cost theory (Rugman, 1981).
The propensity of a certain country to participate in international production is dependent on the extent to which its firms possess these advantages and the locational attraction of its endowments compared to those offered by other countries or regions. Dunning makes no predictions, about which countries, industries or firms are most likely to engage in foreign production. He says that these three advantages will not be evenly distributed across countries, industries and firms. Furthermore, Dunning expects that advantages interact with each other and that their significance and structure may change over time. In this context it is also useful to consider a country's international competitive position through the internationalization process of its firms. Dunning (1979) suggests that there really is a close connection between the ownership advantages of firms and some specific characteristics of countries.
Levitt, Theodore (1983) The Globalization of Markets, Harvard Business Review, May-June.
UNCTAD (2001) World Investment Report 2001: Promoting Linkages, New York and Geneva, United Nations.
Hymer, Stephen (1960, dissertation, 1976, published) The international operations of national firms: A study of direct foreign investment. Cambridge, MA: MIT Press.
 China’s average growth of 10% per year during 1980-2001 (World Bank (2003) World Development Indicators, Washington, DC: World Bank).
 Advertising is the means by which these firms manage demand and create consumer needs where none previously existed. (Galbraith, John Kenneth (1967) The New Industrial State, Princeton University Press).
Rugman, Alan (1996) The Theory of Multinational Enterprises: The Selected Scientific Papers of Alan M. Rugman, Edward Elgar, Cheltenham, U.K. and Brookfield, U.S.
Caves, Richard (1982) Multinational enterprise and economic analysis, Cambridge, Cambridge University Press.
 This is an example given by Bain, Joe (1956) Barriers to New Competition, Cambridge MA, Harward University Press.
 Oligopolistic rivalry refers to rivalry in a market which is shared by a small number of usually large producers or sellers. Each producer is, thereby, obliged in its market behavior to take fully into account the actions and behavior of its current and potential large rivals in the market.
The strategic group theory mentioned earlier is a realistic framework to analyze this kind of mutual learning by doing of interdependent firms.
William Baumol has found that a perfectly competitive market is necessarily perfectly contestable, but not vice-versa. The reason behind this stipulation is that perfect competition is applicable as a guide only if scale economies are absent, so that many kinds of rival firms can prosper. Perfect contestability also rules out productive inefficiency. (Baumol, William (1982) Contestable Markets: An Uprising in the Theory of Industry Structure, American Economic Review, Vol. 72, No. 1, March 1982, pp. 1-15).
 Historical article: Clark, John (1940) Toward a Concept of Workable Competition, American Economics. Review 30, no. 2 (June 1940), pp. 241-256.
Advances in international communication leads to growing similarities in the fashion and music preferences of youths around the world, and to the prevalence of global products such as Coca Cola, Levi Jeans or Sony Walkman.
Levitt, Theodore (1983) The Globalization of Markets, Harvard Business Review, May-June.
The aggregated preferences for certain product in most countries can be of the right type almost simultaneously like the huge prospects of Nokia’s mobile phones demonstrated in the 90s.
Deterrence theory is a theory of war, especially regarding nuclear weapons.
Cross, Adam (2000) Modes of Internationalization, in International Business, Theories, Policies and Practices, Ed. Tayeb, Monir, Harlow, Pearson Education.
 Kumar, Nagesh (1990) Mobility Barriers and Profitability of Multinational and Local Enterprises in Indian Manufacturing, The Journal of Industrial Economics, 38, pp. 449-61.
Kumar, Nagesh (1994) Multinational Enterprises and Industrial Organization: The Case of India, New Delhi, Sage Publications
Kumar, Nagesh (1998) Globalization, Foreign Direct Investment and Technology Transfers: Impacts on and Prospects for Developing Countries, London and New York: Routledge
Kumar, Nagesh, and N.S. Siddharthan (1997) Technology, Market Structure and Internationalization:Issues and Policies for Developing Countries, Routledge and UNU Press, London and New York
 Markusen, James and Venables, Anthony (1997) Foreign Direct Investment as a Catalyst for Industrial Development, NBER Working Papers 6241.
 Ozawa, Terutaka (1996) Companies without Borders: Transnational Corporations in the 1990's. International Thomson Business Press, London.
Sachwald, Frédérique (1994) Competitiveness and Competition: which theory of the firm? In European Integration and Competitiveness: Acquisitions and Alliances in Industry (ed. Sachwald) Edward Elgar Publishing Ltd., Gowerhouse, England.
One estimation is from $104 billion in 1980 to $472 billion in 2005 (These numbers are calculated using data from the World Bank’s Global Development Finance Online database and are not adjusted for inflation) by Anil Kumar in
FDIs can be a green field investment, establishing a foreign affiliate starting new production facilities, or merger and acquisition operation that aims at acquiring control of existing entities.
Ming Zeng and Peter Williamson have studied the strategies and performance of 50 Chinese companies, warn against such complacency, saying: “Multinational executives who do not perceive China's state-owned and privately-held companies as potential competitors have missed the rise of the new breed of Chinese companies that have already succeeded in capturing some foreign markets.” (Zeng, Ming, and Williamson, Peter (2003) The hidden dragons, Harvard Business Review, Vol. 81 No. 10, October, pp.92-9).
 Andersen, Poul Houman (2005) In the shadow of the Dragon and the Tiger: Towards a new understanding of production relocation, innovation and industrial decline, 1. Draft. To be presented at IKE seminar, January 7, 2005, www.business.aau.dk/ike/upcoming/dragon.pdf
 Buckley, Peter and Casson, Mark (1976) The Future of the Multinational Enterprise, London, MacMillan.
Buckley, Peter and Casson, Mark (1985) The Economic Theory of the Multinational Enterprise, London, MacMillan Press Ltd.
 Casson, Mark (1983) The Growth of International Business, London, Allen and Unwin.
 Coase, Ronald (1937) “The Nature of the Firm”, Economica, pp. 386-405.
Williamson, Oliver E. (1985) The Economic Organization Firms, Markets and Policy Control, Harvester Wheatsheaf Books, New York.
 In a perfectly competitive environment, the price system would organise the market with zero transaction costs.
These include long-term contracts through more efficient governance structures, R&D to prevent the dissipation of know-how which is unpatentable; tax differentials and foreign exchange controls, which create incentives for, transfer pricing. In addition, internalization allows the firm to control quality by integrating backwards and internalizing the process to maintain required standards.
Chandler, Alfred (1990) Scale and Scope. The Dynamics of Industrial Capitalism, the Belknap Press of Harvard University Press, Cambridge.
Peters, Thomas (1990) Thriving on Chaos, Harper & Row, New York.
See: Chandler, Alfred D. (1978) The Visible Hand: The Managerial Revolution in American Business, Harvard University Press.
 Rugman, Alan (1981) Inside the Multinationals, London, Croom Held Ltd.
Rugman, Alan (1982) New Theories of the Multinational Enterprise, New York, St. Martin's Press.
 Dunning, John (1980) Toward an eclectic theory of international production: Some empirical tests, Journal of International Business Studies 11(1): pp. 9-31.
Dunning, John (1993) Multinational Enterprises and the Global Economy, Wokinghan England, Addison-Wesley.