The Economic Theory of the Multinational Enterprise

It is conventional to trace the origins of the modern theory of the multinational firm to the doctoral dissertation by Stephen Hymer, written in 1960 and eventually published in 1979. The strands of the theory, however, go back much further, to Coase (1937), Kaldor (1937) and Robinson (1931, 1934). More immediately, Hymer drew heavily on the work of Bain (1956) and Dunning (1958). Current developments suggest a trend towards a general theory of the firm, encompassing the multinational enterprise as a special case (Buckley, 1983).

The theory of internalisation is now widely accepted as a key element in the theory of the multinational enterprise (MNE) (see Chapter 1). Internalisation is a general theory of why firms exist, and without additional assumptions it is almost tautological. To make the theory operational it is necessary to specify assumptions about transaction costs for particular products and for trade between particular locations. It is typically asserted that:

This chapter is an attempt to bring together the rather disparate literature on a topic which is currently identified as an important area in international trade and development — the growth of ‘new forms’ of international industrial co-operation. Such new forms are contrasted with traditional technology transfer through the agency of a wholly-owned subsidiary of a multinational enterprise. Consequently, we are able to identify a spectrum of forms of industrial co-operation from joint ventures between multinationals and host-country interests through a variety of contractual agreements such as licensing, franchising and management contracts to time-limited ‘contractual joint ventures’ and ‘fade-out agreements’.

Cartels have received little attention in the theoretical literature on the multinational enterprise (MNE). This is surprising because of their important historical role in the evolution of the MNE (Wilkins, 1970, 1974). The relation between MNEs and international cartels is complex. In some industries cartels have been superceded by MNEs, while in others the two coexist. The collective behaviour of the members of a cartel often resembles that of a horizontally integrated MNE. Yet different MNEs are often members of the same cartel, and a multi-product MNE may belong to several cartels (see Reader, 1970, and Teichova, 1974).

Analyses of the optimal timing of foreign direct investment (FDI) decisions have been curiously lacking in the general literature on multinational enterprises (see Chapter 1). Although comparative static analyses exist, comparing exporting to the host country with market servicing from a production unit sited in the host country (Horst, 1971; Hirsh, 1976) the only attempt to predict the timing of the switch from exporting to foreign-based production is that of Aliber (1970) (although Vernon, 1966, gives a cost-based rationale for the switch). This chapter attempts to fill this gap in the theory of FDI. Section 5.2 outlines and criticises previous attempts to deal with the problem, Sections 5.3–5.5 present a simple model, which ignores set-up costs, and Sections 5.6 and 5.7 give a more detailed analysis including such costs. Further extensions of the theory are considered in Section 5.8 and the conclusions are summarised in Section 5.9. The problem emerges as being more complex than had previously been appreciated.

The concept of foreign direct investment (FDI) is a rather ambiguous one. To begin with, is the foreign investor the individual whose postponement of consumption enables the investment to be financed? Or is the investor the firm whose shares are owned by the individual concerned, and which owns the real assets on his behalf? If the investor is the firm then by what rules of nationality is it established that the firm is a foreign one — in particular, is there a meaningful economic criterion for the nationality of a multinational enterprise (MNE)?

Dunning (1981) suggests that the behaviour of multinational enterprises (MNEs) can be analysed in terms of three groups of factors: ownership advantages, location advantages, and internalisation. Buckley (1983) notes that of these three, location advantages have received least attention in recent years, despite the fact that, historically, location advantages have strongly influenced the growth of international production (Dunning, 1982). This chapter is an attempt to make good this deficiency.

Analysis of entrepreneurship has been very much neglected by economists. This weakness of orthodox theory is apparent in fields as diverse as economic development, comparative economic systems, investment and business cycles, industrial structure, and the distribution of income (Baumol, 1968). This chapter shows that by relaxing some of the restrictive assumptions of orthodox theory it is possible to develop an economic theory of entrepreneurship which offers insights into international business behaviour.

As Chapter 1 showed, a rich variety of theoretical perspectives on the multinational enterprise now exist. However, there have been few systematic attempts to test the predictions of this body of theory. This has been partly because of the difficulties in framing the right kind of data to test the theories. It is also true that the theories have not been cast in such a way as to project testable hypotheses which can be subjected to empirical scrutiny. The maturity of the theory now makes testing the next task on the research agenda.