Name K.

Murugasen
Roll No. 09MBA29
Class II MBA; V Trimester
Sub International Business

Management
Seminar title Theories of International
Investment

Date of 30December 2010

submission

THEORIES OF INTERNATIONAL INVESTMENT

Introduction:

A number of attempts have been made to formulate a theory to

explain the international investment. A brief outline of the important
attempts in this direction is given below:

 Theory of Capital Movements:

The earliest theoreticians, who assumed, in the classical

tradition, the existence of a perfectly competitive market, considered
foreign investments as a form of factor movement to take advantage
of the differential profit.

The validity of this theory is clear from the observation of the

noted economist Charles Kindleberger that under perfect competition,
foreign direct investment would not occur and that would be unlikely to
occur in a world wherein the conditions were even approximately
competitive.

 Market Imperfections Theory:

One of the important market imperfections approach to the

explanation of the foreign investment in the Monopolistic Advantage
Theory propounded by Stephen in 1960. According to this theory,
foreign direct investment occurred largely in oligopolistic industries
rather than in industries operating under near perfect competition.
Hymer suggested that the decision of a firm to invest in foreign
markets was based on certain advantages the firm possessed over the
local firms (in the foreign country) sucli as economies of scale, superior
technology or skills in the fields of management, production, marketing
and finance.

 Internalization Theory:

According to the internationalization theory, which is an

extension of the market imperfections theory, foreign investment
results from the decision of a firm to internalize a superior knowledge
(i.e., keeping the knowledge within the firm to maintain the
competitive edge)? For example, if a firm decides to externalize its
know-how by licensing a foreign firm, the firm (the licensor) does not
make any foreign investment in this respect but on the other hand, if
the firm decides to internalize, it may invest abroad in production
facilities.

Methods of internalization include formal ways like patents and

copy rights and informal ways like secrecy and family networks.
  Appropriability Theory:

A firm should be able to appropriate (to keep for its exclusive

use) the benefits resulting from a technology it has generated. If this
condition is not satisfies, the firm would not be able to bear the cost of
technology generation and, therefore, would have no incentive for
research and development. MNCs tend to specialize in developing new
technologies which are transmitted efficiently through their internal
channels.

 Location Specific Advantage Theory:

The location specific advantage theory suggests that foreign

investment is pulled by certain location specific advantages. According
to Hood and Young, there are four factors which are pertinent to the
Location Specific Theory. They are:

1. Labour costs

2. Marketing factors (like market size, market growth, stages

of development and local competition)

3. Trade barriers

4. Government policy

 International Product Life Cycle Theory:

According to the Product Life Cycle Theory developed by

Raymond Vernon and Lewis T. Wells, the production of a product shifts
to different categories of countries through the different stages of the
product life cycle.

According to this theory, a new product is first manufactured and

marketed in a developed country like the US (because of favorable
factors like large domestic market, entrepreneurship and ease of
organizing production). It is then exported to other developed markets.
As competition increases in these markets, manufacturing facilities are
established there to cater to these markets and also to export to the
developing countries. As the product becomes standardized and
competition further intensifies, manufacturing facilities are established
in developing countries to lower production costs and due to other
reasons. The developed country markets may also be serviced by
exports from the production units in the developing countries.
  Eclectic Theory:

John Dunning has attempted to formulate a general theory of

international production by combining the postulates of some of the
other theories. According to Dunning, foreign investment by MNCs
results from three competitive advantages which they enjoy, viz.,

1. Firm specific advantages

2. Internalization advantages

3. Location specific advantages

Firm specific advantages result from the tangible and intangible

resources held exclusively, at least temporarily, by the firm and which
provide the firm a comparative advantage over other firms.

 Other Theories:

According to Knickerbocker’s theory of Oligopholistic Reaction

and Multinational Enterprise, when one firm, especially the leader in an
oligopolistic industry, entered a market, other firms in the industry
followed as a defensive strategy, i.e., to defend their market share
from being taken away by the initial investor with the advantage of
local production.