Abstract This paper updates some of the author’s thinking on the eclectic paradigm of international production, and relates it to a number of mainstreams, but context-specific economic and business theories. It suggests that by dynamizing the paradigm and widening it to embrace assetaugmenting foreign direct investment and MNE, activity it may still claim to be the dominant paradigm explaining the extent and pattern of the foreign value-added activities of firms in a globalizing, knowledge intensive and alliance-based market economy. 2000 Elsevier Science Ltd. All rights reserved.
Introduction: the contents of the eclectic paradigm For more than two decades, the eclectic (or OLI1 ) paradigm has remained the dominant analytical framework for accommodating a variety of operationally testable economic theories of the determinants of foreign direct investment (fdi) and the foreign activities of multinational enterprises (MNEs).2 The eclectic paradigm is a simple, yet profound, construct. It avers that the extent, geography and industrial composition of foreign production undertaken by MNEs is determined by the interaction of three sets of interdependent variables — which, themselves, comprise the components of three sub-paradigms. The first is the competitive advantages of the enterprises seeking to engage in fdi (or increase their existing fdi), which are specific to the ownership of the investing enterprises, i.e., their ownership (O) specific advantages. This sub-paradigm asserts that, ceteris paribus, the greater the competitive advantages of the investing firms, relative to those of other firms — and particularly those domiciled in the country in which they are seeking to make their investments — the more they are likely to be able to engage in, or increase, their foreign production.
The second is the locational attractions (L) of alternative countries or regions, for undertaking the value adding activities of MNEs. This sub-paradigm avers that the more the immobile, natural or created endowments, which firms need to use jointly with their own competitive advantages, favour a presence in a foreign, rather than a domestic, location, the more firms will choose to augment or exploit their O specific advantages by engaging in fdi.
The third sub-paradigm of the OLI tripod offers a framework for evaluating alternative ways in which firms may organize the creation and exploitation of their core competencies, given the locational attractions of different countries or regions. Such modalities range from buying and selling goods and services in the open market, through a variety of inter-firm non-equity agreements, to the integration of intermediate product markets, and an outright purchase of a foreign corporation. The eclectic paradigm, like its near relative, internalization theory,3 avows that the greater the net benefits of internalizing cross-border intermediate product markets, the more likely a firm will prefer to engage in foreign production itself, rather than license the right to do so, e.g. by a technical service or franchise agreement, to a foreign firm.
The eclectic paradigm further asserts that the precise configuration of the OLI parameters facing any firm, and the response of the firm to that configuration, is strongly contextual. In particular, it will reflect the economic and political features of the country or region of the investing firms, and of the country or region in which they are seeking to invest; the industry and the nature of the value added activity in which the firms are engaged; the characteristics of the individual investing firms, including their objectives and strategies in pursuing these objectives; and the raison deter for the fdi.
Regarding this last contextual variable, scholars have identified four main types of foreign based MNE activity4: 1. That designed to satisfy a particular foreign market, or set of foreign markets, viz. market seeking, or demand oriented, fdi. 2. That designed to gain access to natural resources, e.g., minerals, agricultural products, unskilled labour, viz. resource seeking, or supply oriented fdi. 3. That designed to promote a more efficient division of labour or specialization of an existing portfolio of foreign and domestic assets by MNEs, i.e., rationalized or efficiency seeking fdi. This type of fdi, though related to the first or second kind, is usually sequential to it. 4. That designed to protect or augment the existing O specific advantages of the investing firms and/or to reduce those of their competitors, i.e., strategic asset seeking fdi
Combining our knowledge of the individual parameters of the OLI paradigm with that of the economic and other characteristics of home and host countries, and of the investing, or potentially investing, firms, it is possible to derive a wide range of specific and operationally testable theories. Thus, it may be hypothesized that some sectors, e.g. the oil and pharmaceutical sectors, are likely to generate more fdi than others, e.g. the iron and steel or aircraft sectors, because the characteristics of the former generate more unique O advantages, and/or because their locational needs favour production outside their home countries, and/or because the net benefits of internalizing cross-border intermediate product markets are greater.
Similarly, it is possible to predict that the significance of outward fdi will be greater for some countries, e.g. Switzerland and the Netherlands, than for others, e.g. Russia and India, simply by knowing about their economic histories, the core competencies of their indigenous firms, the size of their home markets, their experience in foreign markets, and the locational attractions of their immobile resources and capabilities, relative to those of other countries. Finally, some firms, even of the same nationality and from the same industry, are more likely to engage in fdi than others. Sometimes, this might reflect their size — on the whole, large firms tend to be more multinational than small firms; sometimes their attitude to risk — particularly those associated with foreign ventures and of foreign partnerships with foreign firms; and sometimes their innovating product, marketing, locational, or fdi strategies.
The extent and pattern of foreign owned production will depend on the challenges and opportunities offered by different kinds of value-added activity. Thus, the growth of existing, and the emergence of new, markets e.g., in China, over recent years, has led to a considerable expansion of various kinds of market seeking fdi — particularly in fast growing industries, e.g., telecommunications. By contrast, the rate of expansion of several natural resource sectors has been less impressive, as many products have become less resource intensive, due, for example, to the innovation of new alloys, improved recycling techniques, the miniaturization of components, and the replacement of natural by synthetic materials. The reduction of both transport costs and artificial barriers to most forms of trade has led to more efficiency seeking fdi — both among developed countries and between developed and developing countries.5 While, as some kinds of technology have become more standardized and/or more codifiable, licensing agreements and management contracts have replaced fdi, e.g. in the hotel and fast foods sectors, in the more knowledge and trade intensive industries, e.g. pharmaceuticals, industrial electronics and management consultancy, the economies of global integration have made for a dramatic increase in merger and acquisition (M and A) activity (UN, 1998).6 Moreover, the advent of electronic commerce is not only heralding the end of the geography of some financial and information markets, but is revolutionizing the organization of intra-firm production and trade.7
The content and predictions of the eclectic paradigm are firmly embedded in a number of different economic and business theories. Although taken separately, none of these offer a comprehensive explanation of the growth and decline of MNE business activity,8 taken together — i.e., as a group — they do so. Most of the theories, too, are complementary, rather than substitutable, to each other. Some tend to focus on kinds of fdi, but not others. Others are designed to explain different aspects of international production, e.g. its ownership, structure, its locational profile or its organizational form Thus, location theory forms the basis of the ‘where’ of MNE activity; industrial organization and resource based theories of the firm offer some reasons ‘why’ foreign owned affiliates may have a competitive edge over their indigenous competitors; while the concept of the firm as a ‘nexus of treaties’ (Williamson, 1990) is critical to an understanding of the existence of MNEs, and of why firms prefer to engage in fdi rather than sell their O specific assets, or the rights to use them, to independent foreign producers.
Much of this paper will, in fact, seek to demonstrate how, and in what ways, these approaches are complementary to each other; and of how the eclectic paradigm offers both an envelope of these theories, and a common analytical framework within which each can be accommodated and fully enriched in their application.
Finally, the relevance of the individual components of the eclectic paradigm, and the system of which they are part, will depend on whether one is seeking to explain the static or dynamic determinants of MNE activity. For example, one of the earliest theories of fdi, viz the product cycle theory, put forward by Raymond Vernon (1966), was concerned not only with explaining the process by which firms deepened and widened their markets,10 but also how their locational needs might change as they moved from the innovatory to the standardized stage of production. By contrast, much of extant location theory and internalization theory seeks to identify and explain the optimum spatial and organizational dimensions of the existing resources and capabilities of firms and nations. Knickerbocker’s ‘follow my leader,’ and Graham’s ‘tit for tat’ thesis (Knickerbocker, 1973; Graham, 1975) also contain a longitudinal dimension, which, for the most part, is absent in most variants of industrial organization theory, for example as originally propounded by Hymer (1960) and Caves (1971). Initially, too, the eclectic paradigm primarily addressed static and efficiency related issues (Dunning, 1977), but more recently has given attention to the dynamic competitiveness and locational strategy of firms, and particularly the path dependency of the upgrading of their core competencies (Dunning 1995, 1998).
The kernel of this paper is directed to examining the changes in the boundaries, constraints and structure of the eclectic paradigm over the past twenty years;11 and those now being demanded of it by contemporary world events and scholarly thinking. In doing so, it will pay especial attention to the emergence of alliance capitalism12 and the growth of asset augmenting fdi (Wesson 1993, 1997; Makino, 1998; Kuemmerle, 1999). It will set its analysis in the context of four significant happenings of the 1980s and 1990s, viz.: 1. the maturation of the knowledge-based economy,13 2. the deepening integration of international economic and financial activity, including that fostered by electronic networks (Kobrin, 1999), 3. the liberalization of cross-border markets, and the flotation of the world’s major currencies, and 4. the emergence of several new countries as important new players on the global economic stage.
The next three sections will examine how the main intellectual thrust in explaining each of the OLI triumvirate of variables has evolved over this time. It will argue that, as the dynamic composition of these variables has assumed more significance, so the value of the eclectic paradigm has increased relative to the sum of its parts, with the contribution of each becoming increasingly interdependent of each other. Finally, the paper will give especial attention to the contribution of strategic cum managerial approaches to understanding the growth and composition of MNE activity, while averring that the relevance and richness of these is enhanced if set within the overarching construct of the eclectic paradigm.