A Critical Assessment of the Eclectic Theory

INTRODUCTION It is true of everything that the first steps ate both the most important and the most difficult. To begin with, theorization consists of a set of definitions of concepts. The basic concepts underlying the eclectic theory of the multinational enterprise (MNE)(1) are currently being criticized by the internalization theorists(2) in that the ‘ownership advantage' is ‘double counting,' that is, the internalization and location factors are necessary and sufficient to explain the existence and growth of the MNE.The controversy seems to require a thorough examination of the concept of the ‘ownership advantage'. However, the examination should extend further afield. Our objective in this paper is to assess critically the three basic concepts in the eclectic theory, i. e. , the ‘ownership advantage,' the ‘internalization advantage,' and the ‘location advantage' and to suggest the beginnings of an alternative framework to deal with the MNE and FDI (i. e. , foreign direct investment). REDUNDANCY OF THE ‘OWNERSHIP ADVANTAGE'Some Features of the Electic Theory First of all, we must set up the target of our examination. The eclectic theory, Mark I, as advocated by Dunning is as follows [Dunning 1981:79]: 1. It (i. e. , the firm) possesses net ownership advantages vis-a-vis firms of other nationalities in serving particular markets. These ownership advantages largely take the form of the possession of intangible assets, that are, at least for a period of time, exclusive or specific to the firm possessing them. . Assuming condition 1 is satisfied, it must be more beneficial to the enterprise possessing these advantages to use them itself rather than to sell or lease them to foreign firms, that is, for it to internalize its advantages through an extension of its own activities rather than externalize them through licensing and similar contracts with independent firms. 3.Assuming conditions 1 and 2 are satisfied, it must be profitable for the enterprise to utilize these advantages in conjunction with at least some factor inputs (including natural resources) outside its home country; otherwise foreign markets would be served entirely by exports and domestic markets by domestic production. Four features of the eclectic theory should be noted here, as far as they are concerned with our argument. Firstly, needless to say, the concept of the advantage is a relative concept; i. e. advantage of a firm vis-a-vis the others tautologically means their disadvantage vis-a-vis the firm. The advantage is understood from the viewpoint of economic competitiveness and profitability, and thus it takes the form of an economic asset whether tangible or intangible. Thus, the asset value is measured by capitalizing the stream of expected future earnings by means of the rate of return. Secondly, the concept of internalization is interpreted as internalization of an ‘ownership advantage' rather than that of an imperfec t market. 3) Thirdly, the existence per se of the ‘ownership advantage' has nothing to do with the internalization; thus, the ‘ownership advantage' is logically independent of the ‘internalization advantage. ‘ Finally, the ‘ownership advantage' is logically independent of the ‘location advantage;' thus, the ‘ownership advantage' can be measured without referring to location factors. (4) The Logic of the Internalization Theory Let us focus on the second and third features and compare them with the basic logic of the internalization theory. The distinctive feature of the internalization theory is its recognition that the firm is an economic institution, the objective of which is to maximize profit (i. e. , super-normal profit in the Marshallian sense) in the world of market imperfections. The firm attempts to maximize its revenue and minimize its costs: the firm maximizes its organizational benefits after remunerating all the factors of produc tion, R&D, marketing, and management.Firstly, if arm's-length markets are inefficient and incur huge transaction costs, the firm would replace them with its unified ownership and control (i. e. , the internal quasi-market)(6) and minimize its internalization costs;(7) i. e. , the internalization of markets. Secondly, if no market exists for external economies defined to be private costs minus social costs), the firm would bring them under common ownership and control and prevent them from leaking outside; i. e. , the internalization of externalities. 8) Thirdly, if internal economies defined to be private benefits and, at the same time, social benefits) are expected after totally eliminating markets, whether internal or external, the firm would not only internalize the markets but also reorganize and rationalize the activities under the common ownership and control; i. e. , integration under internalization. (9,10) Market imperfections may exist in final-product markets as well as i n intermediate-product markets of physical products (i. e. components and semi-finished products) and intellectual products (i. e. , knowledge or information). final-product markets, however imperfect they are, the firms cannot internalize markets since, needless to say, consumers are independent of producers and merchants. They can only acquire super-normal profit by manipulating their market power. Note that although some academics misunderstood,(11) there is no guarantee that the internalization increases efficiency and social welfare in both intermediate- and final-product markets.On the contrary, it is quite possible that the internalization by the MNE creates imperfect competition or monopolistic (monopsonistic) situations and thus increases social costs by means of restricting the output of high-tech goods, building up an entry barrier by vertical and/or horizontal integration, effective collusion, etc. It is also quite possible that the integration takes part in restricting competition and more than offsets its positive benefits in social welfare. (12,13) In relation to social costs, we should pay some attention to a new concept, perceived transaction costs. Transaction costs can be classified into three categories; i. e. , those inherent in commodity transactions per se,(14) those inherent in oligopolistic or imperfect competition, and those originating from government regulations. (15) Oligopolistic or imperfect competition places competitors in a situation of uncertainty in respect of potential transaction costs as a result of arrn's-length transactions. Concerns about the dissipation of valuable information may well inflate the value of subjectively perceived transaction costs to the extent of virtually prohibiting arm's-length transactions.Uncertainty in oligopolistic or imperfect competition creates self-inflating feature to the ‘perceived transaction costs'. Certain 'embedded social relations' modify pure economic rationality(16) and affec t the choice of internalization. Furthermore, bounded and creeping rationality of the management makes the strategy (i. e. , choosing between internalization, integration, and arm's-length transactions) fairly rigid once it has been decided upon. 17) Internalization, in these circumstances, may be perceived as private-cost minimization, but not as social-cost minimization. 18 Another important feature of the internalization theory is that it expounds interrelations between production, R&D, marketing, and management. (19) The internalization of the markets and externalities of these activities and their integration generate the advantages of the firm over the others. The firm may exercise its market power when it internalizes and integrates them, so as †¦