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Monopolistic Advantage Theory : Stefan Hymer

Stefan Hymer saw the role of firm-specific advantages as a way of marrying the study of direct foreign
investment with classic models of imperfect competition in product markets. He argued that a direct foreign
investor possesses some kind of proprietary or monopolistic advantage not available to local firms.

These advantages must be economies of scale, superior technology, or superior knowledge in marketing,
management, or finance. Foreign direct investment took place because of the product and factor market
imperfections.

The direct investor is a monopolist or, more often, an oligopolist in product markets. Humer implied, that
governments should be ready to impose controls on it.

The Internalization Theory

Is an extension of the market imperfection theory. By investing in a foreign subsidiary rather than licensing, the
company is able to sent the knowledge across borders while maintaining it within the firm, where it
presumably yields a better return on the investment made to produce it.

Other theories relate to financial factors. Robert Aliber believes the imperfections in the foreign exchange
markets may be responsible for foreign investment. He explained this in terms of the ability of firms from
countries with strong currencies to borrow or raise capital in domestic or foreign markets with weak
currencies, which, in turn, enabled them to capitalize their expected income streams at different rates of
interest.

Structural imperfection in the foreign exchange market allow firms to make foreign exchange gains through the
purchase or sales of assets in an undervalued or overvalued currency.

One other financially based theory (portfolio theory) was put by Rugman, Agmon and Lessard. These
researchers argued that international operations allow for a diversification of risk and therefore tend to
maximize the expected return on investment.

Rugman and Lessard have further argued that the location of the foreign direct investment would be a function
of both the firm's perception of the uncertainties involved and the geographical distribution of its existing
assets.

he Eclectic Paradigm
The eclectic paradigm is developed by John Dunning seeks to offer a general framework for determining the
extent and pattern of both foreign-owned production undertaken by a country's own enterprises and also that
of domestic production owned by foreign enterprises.
Table 1-3 identifies some of the more important configurations of the ownership, location and internalization
(OLI) advantages. Some of these can best explains the initial of foreign direct investment (FDI). Others are
more helpful in explaining sequential acts of foreign production.

Industrial Organization Theory

Mainly explains the nature of the ownership (O) advantages that arise: (1) from the possession of particular
intangible assets - assets advantages (Oa); (2) from the ability of the firm to coordinate multiple and
geographically dispersed value-added activities and to capture the gains of risk diversification- transaction
cost minimizing advantages (Ot).
The theory of property rights and the nternalization paradigm explain why firms engage in foreign activity to
exploit or acquire these advantages.
Theories of location and tradeexplain the factors determining the siting of production.
Theories of oligopoly and business strategy explain the likely reaction of firms to particular OLI
configurations.

The eclectic paradigm suggests that all forms of foreign production by all countries can be explained by
reference to the above conditions.

Dunning further argued that the eclectic paradigm offers the basis for a general explanation of international
production.
The propensity of enterprises of a particular nationality to engage in foreign direct investment will vary
according to the economic et al. specific characteristics of their home country and the country(ies) in which
they propose to invest, the range and types of products they intend to produce, and their underlying
management and organizational strategies.
Combining the data in Tables 1-3 and 4 we have the core of eclectic paradigm which, according to Dunning,
offers a rich conceptual framework for explaining not only the level, form and growth of MNE activity, but the
way which such activity is organized.

Furthermore, this paradigm offers a robust tool for analyzing the role FDI; for predicting the economic
consequences of MNE activity, and for evaluating the extent to which the policies of home and host
governments are likely both to affect and be effected by that activity.

The Motives For Foreign Production

Foreign investment my be divided into two components: portfolio investment, which is the purchase of stocks
and bonds solely for the purpose of obtaining a return on the funds invested, and direct investment, by which
the investors participate in the management of the firm in addition to receiving a return on their money. Direct
investment is differently motivated than is portfolio investment.

A foreign investment is treated as direct if the investing entity has a financial equity interest in a foreign
company sufficient to give it some control or influence over the latter's decision taking. Portfolio investment is
an expression of faith in the existing organization and management of the company, and is undertaken to earn
profits or to gain capital appreciation.
Portfolio investment is presumed to involve passive management whereas direct investment is presumed to
involve active management.

It can be identified four types of foreign production (direct investment) undertaken by multinational
corporation:

1. Natural resources seekers. These enterprises are prompted to invest abroad to acquire particular
and specific resources at a lower real cost than could be obtained in their home country (if, indeed,
they are obtained at all).
2. Market seekers. These are enterprises that invest in a particular country or region to supply goods or
services to markets in these or in adjacent countries.
3. Efficiency seekers. The motivation of efficiency seeking FDI is to rationalize the structure of
established resource based or market-seeking investment in such a way that the investing company
can gain from the common governance of geographically dispersed activities.
4. Strategic asset or capability seekers. These MNE engage in FDI, usually by acquiring the assets of
foreign corporations, to promote their long-term strategic objectives -especially that of sustaining or
advancing their international competitiveness.

There are other reasons for MNE activity which do not easily fit into the four categories just described:

 Escape investment. Some FDI is made to escape restrictive legislation or macro-organizational

policies by home governments.
 Support investment. The purpose of these investments is to support the activities if the rest of the
enterprise of which they are part.
 Passive investment. Most direct investments vary in the degree of active management pursued by
their owners, ranging from "complete" to "non-existent". There is some suggestion that the passive
element in the foreign operations by MNEs may be increasing. Those which veer to the passive end of
the spectrum are of two kinds. The first kind of passive investment are those of large institutional
conglomerates that specialize in the buying and selling of companies. The second kinds of passive
investment is that made by small firms and individual investors in real estate. Although classified as
direct, these purchase have more the attributes of portfolio management. The problem of identifying
the passive or portfolio component of a direct investment is not unique to FDI.