Introduction of multinationals in FDI but I am

Introduction

International Business has been written by Charles W. L. Hill. This book is not only inspiring but it is also quite enlightening. The author has a Ph.D. in industrial economics from the University of Manchester’s Institute of science and Technology. He has a vast base of knowledge in teaching. This combined with his excellent skills in writing and global consulting has put him in good stead to write this book which a master piece is touching on numerous issues in international business.

The book has tried to explain the interlocking relationships between such factors as the various economic theories, government policies, business strategies, organizational structures etc in influencing the global economy. The author has maintained a detailed integration of the various chapters where great emphasis is laid upon the decision-making implications of every topic that the book covers. This paper will specifically restrain itself to highlighting the most relevant issues covered in the various chapters.

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International Trade Theory

Several theories about inward Foreign Direct Investment have been advanced. These include; Vernon’s Product Cycle theory, however, the following has also been extensively discussed, Mercantilism, absolute advantage, Comparative advantage, opportunity cost, terms of trade, gains to trade etc (Charles, 2008). This paper will however restrict itself to looking at some theories which have been conceptualized and advanced in relation to inward foreign direct investment (FDI).

Internalization theory

This theory was conceptualized by Buckley and Casson (1976). It largely basis its argument by inferring that licensing possesses three main disadvantages when it comes to consolidating and making good use of discovered foreign markets. These disadvantages are as follows;

It reasons out that investing firms stand the risk of transferring vital knowledge, skills and even machinery to potential offshore business rivals.
It also hold the view that through licensing a firms ability to control such vital areas as manufacturing, marketing and strategizing for profit maximization is restricted.
This theory also reasons out that licensing posses a great challenge to a firm when its competitive advantage is less dependent on its products but rather on its management or marketing strategies.

By and by, internalization theory is a relative analytical way of scrutinizing the behavior of Multinational firms. Internalization theory enhances the scrutiny of the competence and helpfulness of different mechanisms that a state can put in place so as to organize o manage financially viable self supporting relationships in international trade.

Rugman (1976) and (1979) have made it quite obvious that Multinational firms have the benefit of accruing a stable flow of income than indigenous firms of comparable size, and are also able to scheme for better industrial conditions in foreign countries.

Having read quite extensively about this theory, I must confess that I am in concurrence with most of the views expressed about about the effects of licensing and impacts of multinationals in FDI but I am of the opinion that this theory fails to recognize the following; It does not put into focus the fact that most of these multinationals repatriate all or most of the accrued profits back to their mother countries leaving the indigenous population with very little or nothing to show for it.

These huge companies some of which has larger turnovers than the GDP of some of the countries they invest in have also been known to subvert the activities of third world governments resulting in untold suffering for the masses there.

Vernon’s Product Cycle theory

The theory of international product life cycle was conceptualized in the 1960s by Raymond Vernon. This theory holds the view that a firm commences the exportation of its core products which is followed by a subsequent venture into foreign direct investment as these items of trade take on new dimensions as they move on through different stages of their life cycle. In the long run a nation’s exports will turn into its imports.

Even though this theory was originally modelled around the U.S economy being a major exporter of manufactured goods, other countries have made stringent strides towards industrialization and hence it is applicable elsewhere in the world. In the 60’s, the U.S was the leading exporter but recently it has become a major importer since other countries have become more innovative. To explain this phenomenon, Vernon’s international product life cycle theory makes the following observations;

The early stages of production is characterized by products that are not standardized. This implies that issues such as price elasticity communication within the specific industries and products are clearly inherent. However, as these products start to attain maturity in the market, there is a subsequent change in conditions too.

Standardization starts to take effect and this results into greater demands for these products. With increase in demand, offshore markets are encouraged to produce such goods since conditions there offer better opportunities to cut on the cost of overall production due to cheap labor and availability of raw materials.

Hence, firms from the industrialized nations for instance the US are forced to set up production lines in these emerging offshore economies. This results in a reduction in exports. Further maturity of markets in both the industrialized countries and in the offshore markets translates into more standardization.

With reduced costs of production in the offshore economies, pricing emerges as the main competitive criteria. This eventually prompts the international producers to then start exporting back to the developed countries. Hence, going along the tenets of this theory and the evidence adduced as above, one can correctly infer that the more standardized the product becomes the more likely the location of production will change.

Limitations

This theory however has some limitations as follows; First it fails to acknowledge that most of the technologies that are transferred from the developed nations to the less developed nations are more often than not obsolete and insensitive to the conditions on the ground of the adopting countries, Vernon also fails to recognize that there might be challenges posed by laws governing intellectual property when it comes to transfer of technology.

Mercantilism

Mercantilism can be defined as an economic doctrine which holds that governments should take a strict control of foreign trade so as to maintain national prosperity and security. It advocates for a positive balance of trade. It had it dominance in western Europe between the 16th and 18th centuries. Though it is frowned upon by most Western governments today, it thrives under the guise of neomercantilism which is usually practiced in many Asian countries.

This was usually characterized by the following ; high tarrifs on manufactured goods, market monopolization, exclusive trade with colonies, huge export subsidies etc. however this theory has several criticisms namely: (john Lock, 1960) argues that prices vary in proportion to the quantity of money. He further argues that the world’s wealth is not fixed but rather it is constantly being increased by labor. The theory also fails to acknowledge the benefits of comparative advantage.

Theory of Absolute Advantage

While advancing this theory, Adam Smith was trying to counter mercantilism. It is argued that countries cannot become rich at the same time by following mercantilism due to the fact the exports of one given country are the imports of another. He observes that for nations to attain concurrent wealth, then they need to practice free trade and take advantage of their respective absolute advantages.

However, in my opinion the theory of absolute advantage fails to explain why free trade can be advantageous for some trading partners when for instance one country / trading partner has absolute advantage in producing all the goods.

It is there difficult for countries that are disadvantaged to join the free market and compete with those that are more advantaged. Such countries produce cheap goods that cannot compete with the developed countries. Its hard for such countries to pay for the expensive imports. Some countries are more favored climatically as well as being endowed with natural resources.

References

Buckley, P.J. & Casson, M. The Future of the Multinational Enterprise. London: Macmillan. (2000)

Rugman, A.M. (2002). The influence of Hymer’s dissertation on the theory of foreign

direct investment. American Economic Review 75(2): 228-232.

Armstrong, Michael. A Handbook of Human Resource Management Practice. Chicago: Kogan Publishers, 2008.

Jhingan M.L.The economics of Development and Planning. Delhi: Vrinda Publishers, 2003.

Adam Smith. Inquiry into the nature & Causes of the Wealth of Nations. NewYork: State University Press, 2004.

Villard H.H. Economic development. Kansas: Grovefield Press, 2000.

Hart John. Globalization.Journal of Political Economy: retrieved on 20th June 2011 from
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Burton. Alexis. Financial Management. London: Oxford Press, 2003.