UNIT:- 3 Theories of International Investment

International investment theory explains the flow of investment capital into and out of a country by
investors who want to maximize the return on their investments. One of the major factors that
influences international investment is the potential return on alternative investments in the home
country or other foreign markets .The various theories comprises of

Monopolistic Advantages

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. Humerimplied, that governments
should be ready to impose controls on it.

Cross Investment
E. M. Graham). Graham noted a tendency for cross investment by European and American firms in certain oligopolistic
industries; that is, European firms tended to invest in the United States when American companies had gone to Europe.

He postulated that such investments would permit the American subsidiaries of European firms to retaliate in the home
market of U.S. companies if the European subsidiaries of these companies initiated some aggressive tactic, such as price
cutting, in the European market.

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.
Dunning Eclectic theory
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.

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.