Three Theories of the Multinational Firm - Essay Example

?Critically compare and contrast three theories of the multinational firm. Which best explains firm behaviour and why?  Table of Contents Chapter Introduction 3 Chapter 2 – Theoretical Framework 4 2.1 Marxist or the Neo-Imperialist economic theory 4 2.2 Neo-Fundamentalist Marxist economic theory 5 2.3 OLI Theory of International Production 5 Chapter 3 – Evaluation of theories of international production 6 3.1 Similarities between the theories 6 3.2 Differences between the theories 8 Chapter 4 – Conclusion 10 References 11 Chapter 1 - Introduction Multinational firms are those which operate in more than one region; to be precise, in more than one nation. They own a number of subsidiaries depending upon the size of the organisation, which are located in more than one country. However in terms of ownership, they have a nationality while its subsidiaries are only hosted by one or more economies. Usually, the headquarters are located in the owner nation which tends to manage the activities of its branches spread over a vast region. The primary drive operating behind their decision to outspread are the cost benefits and profit potentials which lie in different locations (Maheshwari, 1997, p. 246). However, there are certain aspects which influence the profit and cost factors in a certain region. Those are the very elements which instigate the businessmen to spread out. In fact, theories have been framed by eminent observers in the past, to comprehend the factors which actually guide the production decisions of trans-national companies. Three fundamental factors are ownership, location and internalisation aspects which taken together form the essence of OLI Theory of International Production. This however, is part of the neo-classical school of thought (Taylor & Thrift, 1986, p. 9). Likewise there is the Marxist economic theory or the Neo-Imperialist views which support the decisions taken by trans-national companies to spread out their businesses to different nations around the world. Capitalist economies tend to accumulate a large volume of resources at home which they are restricted from making use of at home due to restrictions imposed over their employment. Hence, they have little option but to generate profit out of their surpluses through deploying them across national borders. Thirdly, the Neo-Fundamentalist Marxist principles say that the primary enticement behind spreading out their businesses is that the industries which gradually acquire a monopolistic position, start enjoying the advantage of huge surpluses. Due to a limited scope for employing them in the nation where they belong, the industrialists deploy them in foreign lands where they have greater prospects of reaping profits (Jenkins, 1987, p. 447-451). The present paper discusses the similarities and differences between each of the three types of economic theories stated above to assess the factors which induce foreign investors towards expanding their businesses across nations. Finally, an evaluation about the theory most applicable in context of business houses today will be made as a concluding note. Chapter 2 – Theoretical Framework 2.1 Marxist or the Neo-Imperialist economic theory According to the views of Marxist economists, the developed and developing economies are complementary to one another and make up the entire global system. However, they also emphasise that the latter are usually the ones who are exploited by the former so that there is a continued outflow of surplus resources from the reserves of developing nations to the already burgeoning stock of the developed nations. The essence of the theory is the monopolisation of industrial houses which leads to an accumulation of huge sums of profits in the capitalist nations. On the other hand, the prevalence of anti-trust laws restricts an expansion of their businesses within the domestic frontier through forming cartels. Thus, the surpluses which are reaped stay idle and hence, attain a stagnant rate of growth which is not desired by the private producer (Jenkins, 1987, p. 448). Hence, they were employed outside the domestic arena where they could be employed for expansion of business. The monopolistic operational nature of the industrial units gradually led to rising prices while expansion plans led to advantages related with economies of scale. Productivity of factor resources had increased but they could not pull down the market prices due to increased market demand. Hence, a huge volume of production surpluses accrued which the capitalist economies drained into the developing nations to expand their branches. This move had been viewed as a benefit for developing nations which strive hard to attain economic prosperity. However, a deeper look would reveal the move to be actually of an advantage for developed nations which aimed at extracting the reserve stocks from developed nations. The final consequence will be the high degree of dependence of the developing nations on their developed counterparts. Given the drainage of their resources, the factor resources available in developing nations would seek employment in the trans-national branches. But, though the cost of factor would be higher in developed economies, their high level of productivity will always beat the weaker group (Dikshit, 1999, p. 232). According to Marxist theories, availability of wealth is but a zero-sum game – it always comes at the expense of loss faced by another entity. They commonly denote foreign investment in developing nations as “blocking development” or “development of underdevelopment” (Jenkins, 1987, p. 448). 2.2 Neo-Fundamentalist Marxist economic theory The neo-fundamentalist Marxists posed a completely opposite view supported by the neo-imperialist economists, assessing that the foreign investors actually patronise growth prospects in developing nations. Observers belonging to this school of thought note that the “private foreign investment “is highly beneficial for less developed economies and actually assists in reducing their dependence on capitalist economies in the long run. The basis of the economic theory is similar to that of neo-imperialists, though they differ in a subtle way. Unlike the latter, the former group of observers do not believe the availability and distribution of wealth to be a zero-sum game, i.e., the accumulation of wealth in one region might not necessarily mean a loss of the same volume of assets in another part of the world. On the other hand, the neo-imperialists have proposed that employment of resources nurtures their productivities which lead to the production of new wealth over time and thus economic prosperity to the developing nations. Thus, it is believed that an influx of foreign surpluses within the frontiers of a developing nation should be regarded as a pathway towards future fortification of the recipient nation. The trans-national business houses complement the productive forces of the developing economies. Furthermore, they also assist in the generation of new resources which could actually influence the growth prospective of the host. Lastly, the developing economies which are the targets of many trans-national corporations are also the centre of competition among the latter. This has actually worked in favour of developing economies which enjoy a bargaining power and have been able to reduce the monopoly rents earned by the multi-national companies hosted by them (Warren, 1980, p. 173-175). 2.3 OLI Theory of International Production The name of the theory is an abbreviation for Ownership, Location and Internalisation factors which are regarded as the most essential aspects guiding the decisions of modern investors. The rationale behind the inclusion of these three factors amongst all has been elucidated below. Commonly, these three factors are the key propositions of the popular eclectic paradigm of industrial production. Scope of Ownership – The trans-national firms assess the net differences or competitive advantages that they have over the domestic business units. These advantages arise out of the former’s ownership of some privileged assets or their unique ability to combine two components available at two different places, so that they attract a high consumer demand and simultaneously poses as a competitive advantage for the foreign companies. Scope of Location - There are a number of factors which define the business environment of a particular locality. Prior to setting up their business, it is essential for the foreign producers to assess the extent of government intervention, economies of scope, transportation and communication expenses, prices of raw materials, availability of factors of production, etc. Scope of Internalisation – The companies often choose to make use of the competitive ownership advantages through internal transactions rather than directly participating in international markets. This saves them on the cost front as the cost of transaction between two overseas branches of the same company is far less compared to the cost of operations in an overseas market (Dunning, 2001, p. 176). Chapter 3 – Evaluation of theories of international production The present section will be engaged in comparing between the three theories of industrial production stated above. While the initial subsection will compare the similarities between them, the latter part will be engaged in pointing out the fundamental differences. 3.1 Similarities between the theories The three theories illustrated above could be regarded as one leading to the next according to the order in which they are placed. The oldest of the three propositions had been the Marxist economic theory which claimed that influx of foreign capital could prove detrimental to the growth of a developing nation and hence, it is wise not to encourage their inflow. In other words, the Marxist economists proposed that it is far better to maintain a closed door policy rather than face long run losses of resources. The next to follow had been neo-Marxist economists who corrected their precursors and asserted that foreign investors indeed could actually nurture growth prospects in an underprivileged region through their economic activities and hence, must be invited to operate in a nation. However, despite differences in their concluding remarks, the basis of similarity between these two theories had been the point where they are rooted. In either case, the foreign investors are forced to spread out their businesses overseas due to restrictions in their operations within their home countries. The industrial units today largely operate in an oligopolistic environment where they are compelled to operate in smaller volumes. Their circle of operation is restricted by government rulings which consider any pact agreed between two oligopolist units to be illegal according to anti-trust decrees. On the other hand, the market share of each unit is highly distinctive and any violation could lead to damaging situations such as price wars. In addition, by virtue of being an old market player, each business house in an oligopolist market has a loyal base of customers who rarely decide to switch their choices. It is amidst such restrictive environment of operations that the industrial units decide to step out of domestic frontiers. Both schools of thought have a similar basis of origination. The Eclectic Paradigm too has a similar basis of origin. The OLI theory of industrial production also stresses upon the cost considerations of operating in a single locale though, the nature of cost is different. However, in either of the two cases, the businessmen have to endure opportunity costs of operating in a single region. The factor which is prominent from the above discussion is that in each one of the three theories, the proponents have stressed upon the basis on which the businessmen decide to spread out. While the reason had been illustrated as the prevalence of anti-trust laws and similar restrictions upon their operation in case of neo-Imperialist and neo-Fundamentalist economic theories, the neo-classical economists too have stressed upon the presence of similar grounds. Although the nature of operational cost is different, the area of similarity is the high cost of operation in the home country. This is the reason why according to the Eclectic Paradigm, the foreign entrepreneurs count upon the location factor highly, which assumes that businessmen make their decisions after assessing the costs associated with locating their branch in a certain area or region. A second area of similarity between the three economic theories is the ownership factor which says that the entrepreneur earns a competitive advantage over other domestic businessmen. This is the reason why they, according to neo-Fundamentalists and neo-Imperialists, have an edge over the domestic resources on the basis of which they can exploit the latter for their own benefit. However, the neo-Fundamentalists like the proponents of the OLI economic theory believe that international investors bring in their resources within the frontiers of the less-developed nations, which actually complement their resources. A final area of similarity between the Eclectic Paradigm and neo-Fundamentalists is that the advocates of both schools of thought believe that the influx of foreign investors is of high benefit to the less developed nations. According to either of the two, the host nation is a prospective area of investment for a large number of trans-national economies, which often means that the former enjoys a bargaining power over the foreign companies which prohibit them from stealing away the independence and sovereignty of the hosts. 3.2 Differences between the theories The three economic theories of industrial production by trans-national companies are found to be different from a number of aspects which is the reason why they evolved. The basis of neo-Imperialist economic theory and neo-Fundamentalist economic theory are found to be similar given that they both originate from the fact that there are restrictions upon the operations of monopolists or oligopolists in their home nations, beyond a certain extent. However, the two schools of thought differ in the impact that the international investors throw upon the domestic companies. While the neo-Imperialist economists believe that international investment could lead to detrimental consequences for the host nation’s resources, it had been found to be quite beneficial for the latter, by the neo-Fundamentalists. The precedents believed that the international investors produce in host nations at the expense of domestic resources. They steal the developing host nations of their indigenous resources and utilise them for their own benefit while depriving the low-income nations. According to the advocates of neo-Imperialism, the distribution of wealth and assets is a zero-sum game where betterment in the economic situation of one is automatically nullified by degradation in the situation of another group. Hence, they claim that allowing international investors to produce within the frontiers of developing nations leads to “development of underdevelopment” and so, it is for the improvement in their situation that the foreigners should not be allowed by the domestic nationals of developing economies. They also claim that not only are the chances of growth retarded for the developing nations, rather the latter adapting a parasitic nature of highly depending upon their developed counterparts. Such a transition could be detrimental for future growth prospects and rob the less-developed economies of their resources on the basis of which they are likely to develop in future. On the other hand, the neo-Fundamentalists though are grounded on similar origins, pose a difference in opinion about the impact that foreign investors could create over their less developed host nations. According to the proponents of this school of thought, the foreign entrepreneurs actually complement the resource endowments of the less developed economies and hence, instigate them towards their growth path. Hence, the neo-Fundamentalists actually complement the indigenous resources of the host nation towards attaining development. This is the reason why the neo-Marxists believe in framing of foreign policies conducive to the inflow of foreign resources within the premises of less-developed nations. Such a stance is adopted as well by the proponents of OLI economic school of thought. Another area of distinction lies in the reason why the foreign investors try to divert their resources to a large number of locations. While the neo-Imperialists and neo-Fundamentalists do so owing to the administrative restrictions prevalent within their home nations, the proponents of Eclectic Paradigm are stimulated by the opportunity cost of limiting their operations within the home nation. The latter consider it to be advantageous for them to spread out, irrespective of the political and social issues in their home nations. Furthermore, the latter are smarter than the former two in the sense that they believe in internalisation of supply. It is more expensive to supply in a foreign market from an overseas office rather than doing so from a domestic branch. This is the reason why the foreign investors decide to open up branches in all those locations where they wish to supply their products. A final point of difference lies in the fact that the proponents of OLI economic theory believe the basis of operating successfully across domestic borders is the competitive advantage that they enjoy over other industrial units – this is where the concept of patents and licensing comes from. However, it is only the weaker and easy-to-conquer nature of less-developed nations that the other two preceding schools of thought regard as the primary cause of operating successfully in the international market. Chapter 4 – Conclusion The present paper dealt with three different theories of industrial production by trans-national economies. These theories have been evolved one out of the preceding one and hence have a large number of similarities as well as differences in their essence. But, the most important aspect is their applicability which decides the efficiency of these economic theories. At present, the OLI economic theory (Eclectic Paradigm) is found to be the one that applies in the global context. Economies around the world today have pinned up their hopes of development upon the inflow of foreign capital within their economies. In fact, this is the very reason behind the popularity of the concept of liberalisation where the economies have relaxed their restrictions over the inflow of foreign resources. An unrestricted free trade regime is what is being highly popularised by different researchers for a unified global economic prosperity. The Marxist economic theories had been prevalent in the past, but unlike what the theory suggests, economies around the world experienced a stunted rate of growth and discovered that they were actually losing many opportunities through their inclination towards a closed-door policy. This had led to the neo-Marxist school of thought which supported liberalisation prospects. However, unlike in this case the OLI economic theory is unsupportive of restrictive domestic activities of industrial units. Hence, industrial units today have an almost free access across national frontiers and this very fact has led to an unprecedented global economic growth today. References Dikshit, R. D. 1999. Political Geography: The spatiality of politics. New Delhi, India: Tata McGraw-Hill. Dunning, J. H. 2001. “The Eclectic (OLI) Paradigm of International Production: Past, Present and Future”. International Journal of the Economics of Business. Vol. 8 (2): 173-190. Jenkins, R. 1987. “Theoretical perspectives on the trans-national corporation” in International Political Economy by Goddard, C. R., Passe-Smith, J. T. & Conklin, J. G. (eds.). London, UK: Lynne Rienner Publishers. Maheshwari, R. P. 2007. Principles of Business Studies (Vol. I). New Delhi, India: Pitambar Publishing House. Taylor, M. & Thrift, N. J. 1986. Multinationals and the Restructuring of the World Economy: The geography of multinationals. USA: Taylor & Francis. Warren, B. 1980. Imperialism: Pioneer of Capitalism. London, UK: Verso. Read More