International Business and the Eclectic Paradigm

John Cantwell, Rajneesh Narula, John Cantwell, Rajneesh Narula

• Publisher: Routledge
• Year: 2003
• ISBN:
  9781134373413
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

The eclectic paradigm has arguably become the dominant theoretical basis in the study of FDI, multinational corporations and internationalisation over the last two decades. The contributions to this volume evaluate the eclectic paradigm in the global economy and its validity as a theoretical basis to understand developments such as economic globali

1

Revisiting the eclectic paradigm

New developments and current issues

John Cantwell and Rajneesh Narula

Introduction

The eclectic paradigm has been the leading explanation for the growth of multinational activity over the past two decades. Its broad appeal has made it a mainstay in explaining various sectors and types of activities. Its simplicity and general nature makes it compatible with a number of schools of economic and managerial thought. It has been applied by management scholars, economic geographers, evolutionary economists, resource-based theorists and development economists, to mention a few. It has also been the object of considerable criticism.

Yet it faces fresh challenges to its continued applicability in the light of new developments associated with the process of globalisation. Economic globalisation and the subsequent growth of global and alliance capitalism have fundamentally affected the way in which international and domestic business activities are undertaken and organised.

Some have pointed to its limited appeal in predicting trends and developments. New forms of activity such as asset-augmenting investment (by multinational corporations (MNCs) of all nationalities and varying levels of multinationality), in a variety and combination of modes of operation such as alliances and outsourcing, have required new ideas and approaches to be integrated within the eclectic paradigm. This chapter systematically discusses these current issues and related relevant theoretical developments, and revisits the eclectic paradigm within this context. The various contributions to the book are then placed within the resulting framework.

We highlight the fact that globalisation has increased the interactive dynamics between, and amongst ‘O’, ‘L’ and ‘I’ characteristics at firm, industry and country level, in at least two ways. First, a knowledge-based society has meant that the efficient exploitation of MNCs’ ownership advantages and the continual need to augment and sustain their competitive advantages is ever more crucial, leading to a complex interdependence between ownership and location advantages. Second, globalisation has affected how MNCs seek to coherently organise their cross-border activities in response to changing boundaries of the firm.

The objective of this volume is to systematically evaluate how the eclectic paradigm has survived the test of time, from a wide variety of perspectives. Contributors were specifically given a remit to discuss whether and how the Ownership-Location-Internalisation (OLI) framework continues to be applicable to the perspective of their own particular analytical concerns. Has the explanatory usefulness of the paradigm diminished? To what extent is it a useful tool from the perspective of (for instance) trade theory, economic geography, evolutionary economics, resource based theory or strategic management? Can it be utilised to explain new developments in international business and economics? Do these require new ideas and concepts to be integrated within the eclectic paradigm? What are the new challenges to which international business theorising must respond?

The continuing usefulness of the OLI framework with the evolution of the MNC

The eclectic paradigm grew out of a desire to synthesise elements from the transaction cost (internalisation) and market power theories of the individual firm in its relationship to markets with macroeconomic approaches to international production (such as the original product cycle model) at the country level. However, it was not intended to be a complete synthesis as it is not possible to fully encompass a set of theories which may address rather different questions or rely on different views of the world. It was therefore soon acknowledged that it was not itself another theory. It was instead intended to provide an overall analytical framework for empirical investigations which would draw the attention of the analyst to the most important theories for the problem at hand. It also provided a framework for a comparison between theories, by establishing the common ground or the points of contact between them, and clarifying the relationship between different levels of analysis and the different questions which theorists have been concerned to address. Thus, for example, internalisation theory may be the most relevant under certain circumstances or when answering certain kinds of questions (such as those related to backward vertical integration into resource extraction, as in the early work of Hennart (1982) or Read (1986)), while the determinants of the competitive strategy of firms in their final product market may be more pertinent in other cases (such as issues of technological competition or cooperation).

These points have sometimes been missed by commentators on and especially by critics of the eclectic paradigm, who have tended to subsume the generality of its framework into one particular theoretical line of argument (some have treated it as a mere extension of transaction cost or internalisation theory) or to one particular level of analysis (such as the firm level); or who at the other extreme suppose that it somehow amounts to an analytical fudge since it doesn't firmly ‘nail its theoretical colours to the mast’. Rather, the eclectic paradigm provides a means of assessing evidence on foreign-owned production in a variety of empirical contexts, as a means of determining which theories and which level of analysis are most appropriate to any given set of circumstances. The paradigm is not therefore a substitute for making judgements over how best to synthesise relevant complementary theories, or how to choose between potentially competing theories. Instead, it provides a framework which facilitates just such judgements, and helps to operationalise them.

In the eclectic paradigm it is contended that MNCs have competitive or ‘ownership’ advantages vis-à-vis their major rivals, which they utilise in establishing production in sites that are attractive due to their ‘location’ advantages (Dunning 1977, 1979, 1988, 1995). According to Dunning, two types of competitive advantage can be distinguished: the first is attributable to the ownership of particular unique intangible assets (such as firm-specific technology), and the second is due to the ownership of complementary assets (such as the ability to create new technologies, or the ability to effectively coordinate cross-border activities). MNCs retain control over their networks of assets (productive, commercial, financial and so forth) because of the ‘internalisation’ advantages of doing so. Internalisation advantages arise both from the greater ease with which an integrated firm is able to appropriate a full return on its ownership of distinctive assets such as its own technology, as well as directly from the coordination of the use of complementary assets, subject to the costs of managing a more complex network.

Frameworks and theories in international business, as in other social sciences, attempt to explain events and developments that have already occurred, and it is axiomatic that things do not stay the same: The behaviour of firms in the future cannot be accurately predicted by their actions in the past. Firms are path-dependent, but not entirely so. To put it another way, there is a vintage effect. The rest of the actors in the economy (institutions, competitors, customers and suppliers) evolve largely independently of a given firm, but changes in their behaviour impinge on its behaviour.

The last few decades have seen a fundamental change in the activities of MNCs. MNC activity has increased not just in its extent, but also in its intensity, and variety. These developments are often associated with the process of globalisation. Economic globalisation refers to the increasing cross-border interdependence and integration of production and markets for goods, services and capital. This process has led to a widening of the extent and form of international transactions, and to a deepening of the interdependence between the actions of economic actors located in one country and those located in others (Dunning 1997). Inter alia, one of the primary consequences of globalisation has been the growing convergence of income levels, consumption patterns and institutional structures, both among the industrialised countries and between them and the more advanced developing countries; and also the increasing significance of intra-firm trade in goods and services. The influence of globalisation on international business activity has ushered in fundamental changes in which MNCs undertake cross-border activities, in what Dunning (1995) has described as ‘alliance capitalism’.

It is hard, if not impossible, to establish clear causalities between developments relating to globalisation, but their interdependence is unmistakeable (Narula 2003). For instance, the kinds of technologies across countries have shown to have converged because of, inter alia, increasing cross-border competition and the increasing interdependence of economic actors in different locations. These developments have changed the way firms organise their innovative activity both spatially and organisationally. There is also an increasing international aspect of R&D activity, and a growth in the use of collaborative R&D, both within and across borders. Competition is global in nature, and this affects the way in which firms sustain their competitiveness. Cantwell and Sanna-Randaccio (1990) have shown, for instance, that firms seek to emulate the technological advantages of leading competitors in the same industry, regardless of their national location. Similarly, Narula and Hagedoorn (1999) have shown that firms seek to engage in R&D alliances with technological leaders in the same industry, irrespective of their national origins.

Firms increasingly seek to invest abroad for a growing variety of reasons, and while asset-exploiting activities still predominate as a motivation, the tendency for firms to invest abroad in order to augment their existing assets is now also substantial, and forces scholars of international business to rephrase their enquiries.

Thus, while the early question in the international business literature was ‘why do technologically advantaged firms go abroad to exploit their advantage (and transfer their technology internally to be able to do so)?’, with the rapid expansion of activity in now-established MNCs from a wider range of home countries a second question has arisen, namely, ‘why do existing MNCs source technology creation internationally through an internal network of geographically dispersed affiliates?’ The eclectic paradigm is equally applicable to both these kinds of question. Thus, in the 1980s those of us that continued to insist on the concept of ownership advantages as a condition for international corporate expansion reformulated the concept more precisely. Critics of the concept had focused their attack on an interpretation of Hymer's earliest discussion of ownership advantages, as a net cost advantage of foreign-owned over indigenous firms in the relevant local market (and this is still often the version that critics prefer to disparage today, seemingly unaware that the discussion, like the real world, has moved on!).

The first and obvious revision is that ownership advantages must be thought of in relation to the international competition mainly from other MNCs rather than relative to domestic companies in a particular host country. Today MNCs are generally competing with one another in international markets, they are usually not in the earliest stages of inter-nationalisation and their investments are not all of a local market-oriented kind (unlike in Hymer's case, in which he had addressed the more specific question of why firms initially go abroad and begin to engage in outward direct investment). Indeed, beyond the notion that firms evolve in their intensity of overseas activity, the internationalisation sequence argument whereby firms first export, and then engage in foreign direct investment (FDI) has now largely been abandoned. Firms in certain sectors skip exporting, and proceed directly to FDI, still others seek to augment assets in several locations, sometimes without any other prior asset-exploiting activities overseas. It is not unusual for MNCs to use several organisational modes simultaneously in the same location, and with the same partners (Benito and Welch 1994; Petersen and Welch 2001).

Second, innovation and hence innovative advantages are differentiated and relative concepts, not indicative of some notional technology frontier. All surviving MNCs have some distinctive competitive edges, and it is these differentiated firm-specific strengths that constitute each firm's ownership advantages rather than some overall absolute cost advantage. Hence, MNCs that are not world leaders or do not hold an overall absolute cost advantage over most indigenous firms in the countries in which they invest may still have ownership advantages especially in operating in certain differentiated kinds of environment, and some of them have been able to upgrade these advantages more rapidly than in the past, encouraging and facilitating a faster internationalisation. Third, therefore, there is a complementarity between the initial ownership advantages of the firm and its ability to consolidate and extend these advantages through an international network of competence-creating subsidiaries. MNCs with greater initial ownership advantages have a greater absorptive capacity to be able to extract and utilise the potential for new innovation to be found in foreign centres of excellence. So it is rather facile to counterpose the initial holding of ownership advantages and the ability to build advantages through asset-seeking foreign direct investment, as has sometimes been done by would-be critics of the eclectic paradigm, since actually the two tend to go together. Likewise, in a successful process of international network creation in the MNC, ownership and location advantages are cumulatively developed together, but this does not imply that the conceptual distinction between them is not useful. For a further discussion of the role of ownership advantages and a review of the debate over their necessity see Cantwell (2000a).

Concerning the relationship between ownership advantages and internalisation advantages in the light of the rise of internationally integrated networks in MNCs, the eclectic paradigm provides a suitable framework for an interchange between the evolutionary theory of technological change applied to MNCs (Cantwell 1989, 1994; Hagedoorn and Narula 2001) and the transaction cost approach applied to the theory of the existence of the MNC (Buckley and Casson 1976). Whereas the theory of cumulative technological change, like the work of the classical economists, is a theory of production (and the changing technology of production), as it stands the Coasian theory of the firm, like the neoclassical economic thinking of which it is a criticism, is a pure theory of exchange. Exchange takes place under a variety of institutional arrangements, in markets or within the firm. However, in order to make the Coasian theory of the firm itself evolutionary it would be necessary to specify how transaction costs are themselves influenced by the growth and technological innovation of firms.

As Casson (1986) pointed out, while transaction cost theory specifies conditions under which non-market institutional arrangements will obtain (for example, within the firm), it does so at present to the exclusion of any active role for managerial strategy. In other words, while a theory of the MNC, couched in an exchange framework, can explain the existence of the MNC or the firm, it still left the firm itself as a passive reactor to transactional circumstances. It relates to the external influences on growth, and not to the internal sources of growth which make the firm inherently dynamic when under competition in its final product market. Changes in the organisation or control of production are merely a response to changes in the costs of various exchange relationships in markets or otherwise. This procedure may be justified if one is concerned only with the internalisation of intermediate product markets actively replacing trade between independent parties, but in the evolutionary or resource-based view this is not the main source of growth of the firm.

It seems reasonable to suppose that the accumulation of technology and the growth of production within the firm will affect the transaction costs of exchange. The transaction cost theorist has instead tended to start from exchange in a market, which gives way to more consciously organised control where it is relatively inefficient. Coase (1937) stressed the market conditions which lead to a reorganisation or an extension in the organisation of the firm. However, the nature and extent of a firm's transactions and cooperative arrangements with other firms, as well as its market share, also depend upon its innovative capacity vis-à-vis other firms. As paths of technological development become established within each firm this is likely to affect the conditions of technology transfer between them, which h...