Theories on Multinational Companies

Theories on Multi topic Companies2.1.1. IntroductionIn the process of hold the macrocosm, beginth and business activities of trans subject companies, conf consumptiond theoretical progressi nonp beils claim been authentic in the past forty years, depending on the scholars fields of specialization, perspective and objectives.It is curiously important to distinguish scotch approaches to the study of transnationals, strategic management approaches, and fin eithery, ethnical approaches to the study of multinational companies.Furtherto a greater extent, the second part of the literature review depart be dedicated to the study of various kinds of spill everyplaces which multinational companies create objet dart operating in the decl ben estate, a subject which is of particular immensity for the topic of this thesis.2.1.2. stinting Approaches to the Study of Multinational CompaniesWhen reviewing the literature on multinational companies, it is evident that economists find themselves at the forefront of the question on multinational companies. According to Cant intumesce (1991 17-18), they ar approaching the topic from three perspectives microeconomic (which deals with cross-b edict interactions of single flyings), mesoeconomic (which deals with the cross-border interactions of faithfuls at the industry level), and macroeconomic (dealing with the growth and trend of multinationals at national and external level). All of these categories fool one thing in parking lot they all(a) tend to let off the existence of supranational performance.The economic approaches to the study of international business cast been dominant in the fields of microeconomics, industrial economics and macroeconomics. These include the surmisal of the impregnable by Coase (1937, 1987), as well as incorporation possibility by Buckley and Casson (1976) and Rugman (1980, 1980 and 1982). Other famous theories on multinational enterp d cutting nears refer to deals and hierarchies approach by Williamson (1975, 1985), furthermore, mart power approach or the system of international operations by Hymer (1960, 1976), and the approaches of industrial formation by Bain (1959), Caves (1971, 1982), Hirsch (1976), Johnson (1970) and Lall (1980a).As a starting point for his research, Ronald Coase (1937) departed from the tralatitious microeconomic assumption which states that economic activity is warnmined freely by the hurt mechanism and that the economic corpse works itself. In charge this means that suppliers respond to demand changes, and buyers respond to supply changes by the devote grocery store system, which is viewed as an automatic, responsive process. According to him, opposed to the traditional persuasion that the economic system is being coordinated by the price mechanisms, Coase arguesThis coordination of the various factors of business is, however, normally carried out without the intervention of the price mechanism. As is evident, the meter of vertical consolidation, involving as it does the supersession of the price mechanism, varies greatly from industry to industry, and from firm to firm. It downstairsside, I think, be assumed that the distinguishing mark of the firm is the supersession of the price mechanism. (Coase, 1937 in Williamson and Winter 199120).Furthermore, Coase (in Williamson and Winter 199130) suggests that at the margin, the costs of organizing within the firm entrust be equal either to the costs of organizing in honourable about opposite firm or to the costs baffling in leaving the execution to be organized by the price mechanism. Even though the conjecture of Coase was plethoricly meant for the domestic horizon, it later served as the bases of the internalisation surmisal.The purpose of incorporation has its origins in the theory of industrial coitions. Bain (1959) pursues the proposition that there allow be possibilities of integration by the firm (acquiring and combi ning with supplier firms or customer firms) which, among separatewises, have positive economies or savings in cost. Additionally, he tensiones that atomistic grocery structures with unrestricted competitor leave behind tend to force or make automatic efficiency increasing integration, and managewise tend to deter inefficient integration. Bain further claims that no particular instance of integration will be fully forced in an oligopolistic situation, provided there should be a tendency for oligopolistic firms to integrate if there argon other advantages (other than costs) to the integration that will non result in inefficiency. He asserts that even inefficient integration is possible if it has offsetting advantages (Bain, 1959168).Hirsch (1976) suggested that the optimal choice between international mess and international exertion is determined by the firms precise know guidege advantages and other intangible assets. Rugman (1981 45) uses Hirschs feigning and inte rprets it as one that treats knowledge as an intermediate product which is internalized in the structure of multinational attempt. These ownership advantages everywherethrow effective barriers to institution to rival firms. They enable temporary monopoly power to the attach to by allowing it a possibility to earn profit above the paramount industry level. Hirsch (1976) states that the greater ownership advantages are, the more economics of production and merchandising prefer unusual office and therefore outside(prenominal) admit investiture.Authors Buckley and Casson (197633) give their significant contribution to the theory of internalization based upon three presumptionsCompanies maximise profit in a beingness of imperfect marketsThe imperfect constitution of the markets for intermediate ripes urges companies to avoid them by creating internal marketsInternalization of markets across national boundaries creates multinational enterprises.The main thesis of Buckley an d Casson is that attempts to improve the organization of these markets have led to a radical change in business organization, one prognosis of which is the growth of MNE. Therefore, a multinational enterprise is perceived as an tool used for raising efficiency by replacing orthogonal markets via ontogenesis of internalization advantages within the mannequin of effect costs and exchange.Furthermore, they insist that an MNE is created whenever markets are internalized across national boundaries, and a market in an intermediate profound will be internalized only in the situation when benefits outweigh costs. The authors stress the following Vertical integration of production will give rise to MNEs because varied stages of production require different combinations of factors and are therefore take up carried out in different countries, according to factor availability and the law of nature of comparative advantage. Moreover, there is a special reason for believing that internal ization of the knowledge market will generate a high layer of multinationality among forms (Buckley and Casson 1976, 44-45).Theory of internalization has been sumitionally advanced by Rugman (198128) who pointed out that internalization is the process of make a market within a high society. He suggests that company creates an internal market as a replacement for the missing regular (or external) market and in order to overcome the problems of al mending and scattering by the use of administrative fiat. Furthermore, he states that the internal prices (or transfer prices) of the firm lubricate the organization as a potential (but unrealized) regular market.In reality, the internalization theory pursued by Rugman tries to explain the reasons why a company wishes to go into international production across national boundaries.On this particular subject, Rugman (198129) states the followingA firm will wish to surface itself abroad to gain access to opposed markets. It will get ho ld of contradictory direct investiture when exporting and licensing are unreliable, inferior, or more dear(p) options. Internalization is a device for keeping a firm specific advantage over a worldwide descale. The MNE is an organization able to varan the use of its firm specific advantage in knowledge by establishing abroad miniature replicas of the parent firm. These outside subsidiaries supply for each one foreign market and permit the MNE to segment national markets and use price unlikeness to maximize worldwide profits. Internalization allows the multinational to restrict its affiliates and to regulate the use of the system specific advantage on a global basis.The concept of creating an internal market within a company in order to avoid sexual congressly high transaction costs of the market system is additionally researched by Williamson (1975).In his work Markets and Hierarchies, he suggests that the economics of transaction costs and in general, new institutional e conomics explains why companies ingest to conduct hierarchical expansion instead of conducting economic activity finished and by dint of the market mechanisms.Williamson states that multinational enterprises choose vertical integration or power structure for various reasons in comparison to the market system, hierarchy extends boundaries on rationality by allowing the specialization of decision-making and economizing on communication expense. Furthermore, hierarchy permits additional incentives and control measures to discipline opportunism. Interdependent units are adapted to uncertainties and unexpected events more easily. pecking order also offers more constitutional possibilities for effective monitoring and auditing jobs, which consequently narrows complicate the information gap which appears in the case of autonomous agents. Finally, hierarchy provides a less calculative exchange atmosphere or environment (Williamson 1975258). Scholars like Kay (1991) and Lee (1994) ack nowledged Williamsons emphasis on asset specificity as a key environmental factor, coupled with uncertainty, which leads to hierarchy or vertical integration. asset specificity actually represents specialization of assets with respect to use or user. It appears when one or both parties to the transaction invest in equipment, which has been spirited especially to fulfill the transaction and has reduce value when used for other purpose. Williamson (1985) states that spot markets will probably fail under the condition of asset specificity. This occurs because party making transaction-specific enthronements, and for whom the costs of switching partners are consequently high, will fear that one flexible party will opportunistically renegotiate the terms of trade. Asset specificity as a determinant of vertical integration is crucial in relation to given conditions of bounded rationality, opportunism and uncertainty. Asset specificity is the big locomotive to which transaction cost ec onomies owes much of its predictive content. Its neglect is largely responsible for the monopoly concentration of primitively contract traditions (Williamson 1985 54-56).One of the gurus of theory on multinational enterprises is for certain Richard Caves. Caves (1971, 1982) presumed that founding of subsidiary by a multinational enterprise amounts to access into one national market by a going enterprise based on about other geographic market. One possibility of entry is horizontal expansion, when a subsidiary produces the aforesaid(prenominal) type of product as the parent company. Other type of entry is vertical expansion or integration across national boundaries either backward to produce raw materials or intermediate products used in its home operations or forward to provide a distribution channel for its exports (Caves 1974a, 117).Additionally, Caves assumed that foreign direct enthronisation appears mostly in industries voiceized by certain market structures in both h ome or host countries. He concludes that some(prenominal)ise oligopoly prevails mostly in the case when companies opt for horizontal expansion. On the other hand, oligopoly, not necessarily differentiated, in the home market is typical in industries which press vertical expansion across national boundaries. Direct investment tends to involve market conduct that extends the recognition of mutual market dependency the essence of oligopoly beyond national boundaries (Caves 19711).Additionally, in order to explain the comportment of multinational companies, Caves distinguished and explained three types of multiplant companies horizontally integrated company which produces the similar line of products from its plants in each geographic market, vertically integrated, which produces outputs in some of the plants that serve as inputs for other plants, and finally a diversified company whose plants outputs are neither horizontally nor vertically related to one another (Caves 1982a2) .With his theory of international operations, Hymer (1960, 1976) emphasized two major causes of international operations growth of oligopolistic advantages and suspension of conflicts between companies in order to strengthen market power by means of collusion. Therefore, Hymer states the following It frequently happens that enterprises in different countries compete with each other because they sell in the akin market or because some of the firms sell to other firms. If the markets are imperfect, that is, if horizontal or bilateral monopoly or oligopoly, some form of collusion will be profitable. One form of collusion is to have the various enterprises owned and controlled by one firm. This is one penury for firms to control enterprises in foreign countries (Hymer 197625).Furthermore, he states that FDI could not be explained as if it were portfolio investments that is, inter country movements of capital responding to differential coefficient rates of return on capital. If thi s direct investment is incite by a desire to earn higher enkindle rates abroad, this behave of borrowing substantially abroad seems strange(Hymer 197613).Hymer emphasized that international operations type of investment does not depend on the interest rate. The direct investor is motivated by profits that are obtained from controlling the foreign enterprise, not by higher interest rates abroad (Hymer 1976 26-30). He suggested that direct investments are the capital movements associated with the international operations of companies. According to him there are several types of motivation. The underlying motivation for controlling the foreign enterprise is to eliminate competition between that foreign enterprise and enterprises in other countries, and to form a profitable collusion among them. Another motivation is control which is desired in order to appropriate completely the returns on certain skills and abilities. The other motivation arises from the fact that a firm with advan tages over other firms in production of a particular product may find it profitable to undertake the production of this product in a foreign country as well (Hymer 1976 25-26).Another contribution which is even more fundamental do by Hymer, was to argue for the link between market failure and FDI. Hymer pioneered an oligopolistic theory of the growth of production straighten outworks across national boundaries, finished collusion and exploitation of ownership advantages in a market power context, instead of a location theory context. The market power school of thought pursues that internationalisation lowers the extent of competition and increases collusion among firms, in general (Cantwell 1991a30).Due to their relative abundance of capital but scarcity of labor, traditional neo-classical economics assumes that countries which are economically real have low profit or interest rates but high wage rates prior to international operations. Therefore, capital intensive goods go fr om economically substantial countries to less developed labor abundant countries. There can also be a tendency for capital generous countries to export capital directly through foreign direct investment in growth countries. In the same expression, economists that belong to the Marxist school of thought, advocate the idea that there is a tendency for the rate of profit to decline in capital rich countries, due to the intensity of competition. Consequently, foreign investment in less developed or underdeveloped countries serves as an outlet for surplus capital (Cantwell in Pitelis and Sygden 199120).Recent historical data, however, reveal a trend which challenges stipulations of the traditional neo-classical and Marxist theories. Before 1939, imperialistic and colonial influences have been determining factors which influenced international trade and investment between hegemonic countries and developing countries. Similar trade and investment patterns prevailed in 1950s, but the trend started to change in the past few decades. In 1950, around three fifths of manufacturing exports from Europe, North America or Japan were direct to the developing countries across the world, but by 1971, only just over one third (Armstrong et al., 1984251).Additionally, Dunning (1983b88) acknowledged that two thirds of the worlds stock of FDI was located in developing countries in 1938. This amount has fallen to just little over a quarter by 1970s (cited by Cantwell in Pitelis Sugden 199120). During eighties and 1990s significant capital mobility among developed countries overshadowed foreign direct investment in the developing countries. Mergers and acquisitions were the main trade mark of multinational production activities across the industrialized world during this period. At the time, in the developing world FDI have been characterized by critical point ventures, privatization ventures and pioneering projects in the field of manufacturing and infrastructure (World Econo mic Forum 199728). During the 1990s, economically developed countries were still the most favorable end of FDIs. However, this period has been significant since a large flow of capital invaded uphill markets, especially the ones in Asia where incentives for foreign investments have been extremely attractive. China, for instance, received $42.3 jillion in 1996, which accounted for 38 percent of total FDI flows to the emerging markets in that year. Additionally, other emerging markets in Asia, such as Malaysia, Indonesia and Thailand became increasingly significant recipients of foreign direct investment (World Economic Forum 199728-30).On a macroeconomic level, different approaches have been developed in order to explain cross-border activities of multinational companies. The most important ones are the following the product cycle posture by Vernon (1966), trade and direct foreign investment model of Kojima (1978), location theories of the division of labor as analysed by Buckley and Casson (1976), Casson (1979,1986), Casson et al. (1986) and Buckley (1988), investment-development cycle advanced by Dunning (1982), stages of development approach by Cantwell and Tolentino (1987) and the eclectic figure by Dunning (1977, 1981, 1988, 1993a, 1995a, 1995b). point of intersection cycle model, as defined by Vernon (1966) represents a combination of a three-stage theory of innovation, growth and maturing of a new product with the RD factor theory (Kojima 197861). The latter theory presumes where a new product or engine room is most likely to be created. In this new phase stage, design of the product is often being changed and therefore, its production is expertly unstable and the market is not enough acquainted with the product. Consequently, the sales will not grow rapidly and the demand for the product will remain price-inelastic. In this phase, research and development activities of scientists and technicians are of crucial importance for the first appearan ce of inventions and changes in design. Theoretically, the introduction of the RD factor in the product cycle theory represents the addition of a factor of production to the conventional two- commodity, two-factor model.If this approach is accepted, it follows that one may add new factors of production one by one in a similar manner.At the growth phase which comes after the first one, sales of products increase. Mass production and bulk sales methods are introduced. At the same time, entries in the industry increase and competition grows among producers. Demand becomes price-elastic and therefore, sales of each firm become more responsive to the price. Under these circumstances, the realization of economies of scale and managerial ability of the company play important role (Kojima 1978 62).Finally, when the good phase is reached, the product becomes standardized and its production technologically stabile. Instead of the crucial role that is played by research and development activi ties or managerial abilities in the new-phase stage and growth stage, unskilled and semi-skilled labor become important. Therefore, through foreign investment production location is being directed to low-wage, developing countries. The expenses of marketing or exporting the product from these countries may be lower compared to other commodities, since the commodity is standardized.Kojima (1978) gave several comments on Vernons product cycle theory. Firstly, the theory is not founded on the principle of comparative costs. Vernon himself elaborates that his theory discusses one shining line of generalization and synthesis, which appears to have been neglected by the main flow of trade theory. It does not stress the comparative cost doctrine but instead emphasizes more the timing of innovation, the effects of scale of economies, and the roles of ignorance and uncertainty in influencing trade patterns.Secondly, this theory tries to explain the location of production of one commodity b y a firm growing through monopolistic or oligopolistic behavior (Kojima 197863).Kojima (1978) suggested the so-called trade and deficit foreign investment theory as an alternative approach to the study of multinationals. Furthermore, he suggested that foreign direct investment should complement comparative advantage patterns in different countries. much(prenominal) advantage has to originate from the comparatively disadvantaged industry of the source country, which leads to lower-cost and spread out volume of exports from the host country.Significant criticism of Kojimas theory is the manner in which import-substituting investments are referred to as anti-trade lie. While import-substituting investments could be considered as anti-trade oriented at the microeconomic level, they are not anti-trade oriented at the macroeconomic level. In fact, an increasing level of exports usually follows the growth of FDI from USA, Germany and Japan. There are proofs which suggest that export-ori ented investments may have a less significant tint in industrial adjustment or in increasing the eudaemonia of the host country since these investments are likely to be an enclave kind (Dunning and Cantwell 1990 as cited in Tolentino 199351).Rugman (198147) suggested his main objection with Kojimas analysis is that it is set in the static framework of trade theory, meaning that his model requires perfect markets. It is simply a mistake to observe engine room as a uniform product over time and to ignore the dynamic nature of the technology cycle. It is probable that the United States have a comparative advantage, not in technology itself but in the generation of new knowledge. Consequently, it is feasible for US FDI in technology to take place to secure new markets on a continuous basis, as successive stages of the technology cycle are used, firstly in domestic markets and than in foreign ones.Dunning (1982, 1986) contributed to the investment-development cycle model with his sug gestion that the level of inward and outbound investment of different countries, and the balance wheel of the two, is a function of their stage of development as measured by GNP (gross national product) per capita. After threshold phase of development, outer investment increases for countries at yet higher levels of development. The balance between inward and external investment in developed countries results in the return of their net outward investment to zero. The continued growth of their outward investment at a later phase results in a positive net outward investment (NOI).Tolentino(1993) offered empirical evidence for the period since the mid-1970s which imply that the existence of a structural change in the relationship between NOI and the countrys relative stage of development as a consequence of the general rise in the internationalization of firms from countries at lower stages of development. The growth of newer multinationals from Japan, Germany and smaller developed countries, as well as some of the richer developing economies, implies their firms capacity to follow the earlier outward multinational expansion of the traditional source countries, the USA and the UK, at a much earlier stage of their national development. The enhanced implication of outward investments from these newer source countries enables firm evidence of the general trend towards internationalization do that the national stage development no longer becomes a good predictor of a countrys overall net outward investment position.Cantwell and Tolentino (1987) suggested the stages of development approach to the study of multinationals. They posed a hypothesis that the character and composition of outward direct investment changes as development proceeds. Additionally, the verbalize the followingCountries outward direct investment generally follows a developmental or evolutionary course over time which is initially predominant in imaging-based or simple forms of manufacturing production which embody limited technological requirements in the earlier stages of development and then evolve towards more technologically sophisticated forms of manufacturing investments. The developmental course of the most recent outward investors from the threesome World has been faster and has a distinctive technological nature compared to the more mature multinationals from Europe, USA and Japan, owing to the different stages of their national development.Dunning (1977, 1981, 1988, 1993a, 1995a, 1995b) and his eclectic picture tends to explain the ability and willingness of companies to serve markets across national borders. Furthermore, the eclectic paradigm attempts to elaborate why they opt for the exploitation of any available advantages through foreign production instead of using domestic production, exports or portfolio resource flows. He hypothesized that a company will go for international production or engage in foreign direct investment if it owns net ownership a dvantages (mostly in the form of intangible assets) vis--vis firms of other nationalities in part particular markets. These ownership advantages, accompanied by internalization and location possibilities, will enable a company to benefit when using or internalizing a particular foreign market itself, instead of selling, renting or leasing them to foreign companies.Location possibility in this context means locating a multinational firms production activity in a foreign country that possesses competitive advantages in terms of factor endowments. If these three conditions (ownership, location and internalization) are not present, the firm can instead serve its local market through domestic production and expand it to serve foreign markets through international trade. The bigger the ownership advantages of multinational companies, the more incentive they have to use these themselves. The more the economics of production and marketing favor a foreign location, the more they are likely to engage in foreign direct investment. The propensity of a particular country to engage in international production is then dependent of the extent to which its enterprises possess these advantages and the location attractions of its endowments compared with those offered by other countries (Dunning 198179).According to Dunning eclectic paradigm is perhaps, the dominant paradigm of international production. It presumes ownership specific advantages as endogenous variables, i.e. to be a determinant of foreign production. This means that the paradigm is not only involved with answering the question of why firms go for FDI, in preference to other modes of cross-border transactions. It is also concerned with why these firms possess unique resources and competencies relative to their competitors or other nationalities and why they choose to use at least some of these advantages together with portfolio of foreign-based immobile assets. This makes it different from the internalization m odel, which regards ownership advantages as exogenous variables (Dunning, 1993a252).As perceived by Dunning, the eclectic paradigm is meant to capture all approaches to the study of international production. In his opinion the model represents a good starting point to discover the global explanation of MNEs existence and growth since it synthesizes the explanations of the existence and nature of international production.Dunning states that his eclectic paradigm can give an adequate analytical framework which enables understanding of all kinds of foreign production in services. Stressing the interdependence between services and goods industries, he asserts that it makes no sense to try to develop a new paradigm to explain the transnationality of the service sector (Dunning 1993a248-284).In his scholarly research, Dunning was assertive to find all possible explanations of the existence of multinational enterprise in his eclectic paradigm. As the years went by, he tried to expand know ledge in the framework of his eclectic paradigm by attempting to accommodate possible additional explanations to multinational production activity that come to his knowledge.As an example, for instance, he argues that the advent of cooperative alliances among multinational firms does not lead to the development of a new multinational theory. Therefore, he has incorporated alliance capitalism in his model. In his renew version of the eclectic paradigm in the light of alliance capitalism, Dunning(1995a) considers that inter-firm alliances (with unaccented reference to American multinationals) in innovation-led production systems are emerging as dominant forms of market-based capitalism, and are overtaking the global influence of hierarchical capitalism. Dunning has rivet on the narrow view of the value-adding activity of innovation-led capitalism, and has considered other joint ventures, not wholly owned production operations, dominate the multinational enterprise interlocking in less developed countries (Vaupel and Curhan 1973).Both in theory or in practice, internalizing a foreign market and going for a joint venture alliance with a foreign partner are just two possible options that a multinational company can choose in international business activities. Therefore, alliance as a schema can be the dependent variable, just like international production, that inevitably further explanations. Explanations to joint ventures overseas could also include ownership, location and internalization considerations. Border lines between the three levels of economic analysis microeconomic, mesoeconomic and macroeconomic have to be neglected in order to synthesize the various economic approaches to the research of multinationals.Modern economic explanations of cross-border production activities of multinational firms are mostly reflected in the configuration of ownership, internalization and location advantages. Dunning has integrated those three fractions under the w ing of his eclectic paradigm, but his primary objective in doing so is still to find eclectic explanations to the phenomenon of international production.Despite the differences in academic specialism, perspectives and objectives of economists who pursued the study of the existence of multinational companies and made significant contributions this field, they have one thing in common they all targeted the explanation of the phenomenon of international production activity across national boundaries.2.1.3. Strategic Management Approa