Role of Dunnings OLI Model in Foreign Direct Investment - Research Paper Example

Introduction The paper discuss the ment that whereas Dunning’s OLI model provides a general paradigm for explaining the determinants of the Foreign Direct Investment, its use in designing an international corporate strategy, as defined by Head, is limited and requires more specific models for the task. The discussion will showcase the limitation of the Dunning’s OLI model by uncovering whether there are other new typologies that have been presently proposed to justify the assertion (Dunning, 1995). In particular, the researcher looks at the proposed new typology with respect to O-advantages as a purpose of their discrepancy management consequences in established multinational enterprises (MNEs). The internalization theory illustrates that the fundamental reasons for Multinational enterprise to indulge in Foreign Direct Investment is to internalize the most component of the process of production. Such a purpose of FDI reduces the usual business risks and provides the MNE economy-of-scale merits. Therefore, the Dunning’s electric paradigm reaffirms such a purpose of FDI and integrates it further with corporate monopolization and national comparative advantage (Dunning, 1995). The proceeding discussion will thus showcase the how the relevant to the statement through an in-depth investigation of the Dunning OLI paradigm with respect to its use in designing an international cooperate strategy and further showcase the model is limited and suggest the appropriate specific models it requires. Body The point of argument is that the mainstream typology of O advantages projected in Dunning’s electric paradigm does not recognize the uniqueness of each firm. The critic, therefore, proposes a new typology of O advantages that separates among four types depending on the geographic sources of such merits and their transferability across the borders. Furthermore, the critics acknowledge the significance of resource recombination advantages. The Electric Paradigm provides a general framework for illustrating international production. The paradigm encompasses three variables, ownership-specific (O) location-specific (L) and internalization (I) as already recognized in the previous theories of trade and Foreign Direct Investment (Dunning, 1995). The paradigm is commonly referred to as the OLI framework and position itself at the intersection of a macroeconomic theory of international trade (L) and a microeconomic theory of the firm (O-specific advantages and I-specific advantages). The paradigm is, therefore, an exercise in allocation of resources and organizational economics. The fundamental principle is that the all the trio-factors (OLI) are essential in determining the degree and pattern of the Foreign Direct Investment (Caves, 1971). The Ownership specific variables encompass tangible assets like natural endowment, capital, and manpower as well as intangible assets such as information and technology, marketing, entrepreneurial systems and managerial (Caves, 1971). Location-specific (country-specific) variables entail such factors as market structure, government policies and legislation, political, legal cultural environments where FDI is executed. In addition, the third variable (internalization), includes the firm’s inherent flexibility and capacity to produce and market via its internal subsidiaries. Also, internalization is the incapability of the market to produce a satisfactory deal between potential buyers and sellers of intermediate products that illustrates why MNEs frequently select internalization over the market route for exploiting variations in comparative advantages between nations. The electric paradigm discriminates between structural and transactional market failure. Structural market failure is perceived as an external phenomenon that results in monopoly advantages due to entry barriers pegged or escalated by incumbent government and firms (Caves, 1971). The structural market failure, therefore, segregates between firms with respect to their capability to benefit and sustain control over property rights and to govern geographically dispersed value-added activities. On the other hand, transactional market failure results from the failure of intermediate product markets to transact commodities at a lower cost than the costs incurred through internalization. The electric paradigm offers a more synthesized perception illustrating the Foreign Direct Investment as compared to the product life-cycle theory, the internalization theory, and monopolistic advantage theory (Itaki, 1991). The paradigm merges and integrates country-specific, ownership-specific and internalization variables to articulate the logic and benefits of the international production. However, the present international business environment and Multinational Enterprises (MNEs) behavior are evidently distinguished from the previous two decades, during the inception of the Dunning’s OLI model, the paradigm is still key to illustrating why Foreign Direct Investment occurs as well as areas where MNEs’ superior returns originate. Just like other theories of FDI, the electric paradigm has devastating shortcomings. The model is silent and does not discourse adequately how an MNE’s ownership specific advantages like distinctive resources and abilities need to be deployed and exploited in international production (Strandskov & Pedersen, 2000). Despite the significance attached to the possession of such resources, however, it never produces high returns for the MNE least they are effectively deployed, allocated, and used in foreign production and operation activities. In addition, the paradigm does not unambiguously delineate the ongoing, evolving process of international production. Foreign Direct Investment itself is a dynamic process where resource commitment, production scale, and investment mechanisms are fluctuating over time. Moreover, the conventional wisdom seems unsatisfactorily in illuminating how geographically distributed international view address how an MNE could exploit and circumvent market failure in regard to intermediate products and services but never deliberate how a firm could integrate a multitude of sophisticated international production and balance global integration with local adaptation (Strandskov & Pedersen, 2000). Therefore, redressing such limitations has attracted numerous new theoretical views in recent years. The paradigm use in designing an international corporate strategy, as defined by Head, is limited and requires more specific models for the task based on the several criticism that have evolved to criticize the model (Dunning & Narula, 1996). The Paradigm is criticized due to its broad and loose structure. A key issue is whether the approach that lumps evidence for O, L and I-advantages are operational. O, L and I depict necessary conditions and never sufficient conditions for Foreign Direct Investment. Firms had to possess several competencies for O to be just “necessary” and that was so unclear, however, as was the degree of importance necessary for I-advantages to guarantee an FDI (Strandskov & Pedersen, 2000). Moreover, the criticism is focused on the three types of advantages, and a daunting challenge is whether they are independent and necessary. The intersection between the O and I advantages is severely blurred and thus O and I advantages are noted to be inevitably inseparable. The O-advantages are redundant with respect to being logically categorized as internationalization advantages developed over time. The OLI model has thus been revised and adjusted over the period. The revisions and the adjustment attracted by the OLI model may not necessary appear as the responses towards fierce debates on MNE. The Dunning (1995) shifted the focus towards alliance capitalism and more or less extended the entire framework to cooperative ventures of all sorts. Therefore, the strategy is to add a range of new O-advantages relating to the capability to build and sustain vertical and horizontal networks. In so doing, advantages are appealed to be valid for cohorts of cooperating firms and the individual MNE. Therefore, the resource dependency mechanism has been enhanced, and the attention been widened to incorporate the O advantages of foreign companies (Strandskov & Pedersen, 2000). As a result of the limitation identifiable, Dunning redefined the subject matter of the electric theory and subsequently shifted his exclusive international production to integrate all value-creating activities. Such a strategy is a key step in breaking away from the bondage of Dunning’s former formulations of the paradigm that in conjunction with the relational O advantages, heralds a new and broader theory of internalization. The positive adjustment in the OLI paradigm is that the electric paradigm adds generality when other entry modes a part of FDI are considered. On the other hand, the downside is that OLI is assumed to explain just about anything by merely adding an extended portfolio of variables (Strandskov & Pedersen, 2000). The initial Dunning formulation of the electric paradigm was exclusively for use an FDI theory that was unnecessarily limited and can be easily extended into a general theory of internationalization. A counteractive new deal for the limitation of the OLI electric paradigm is where O advantages possessed by the investing MNE that were only a necessary condition for the internalization of production activities, the production is substituted with value creating activities to allow the deployment of upstream and downstream resources across borders (Dunning, 1997). The dynamic capability perspective points out that ownership-specific resources are only necessary but inadequate for the success of international investment and production. Such a success depends not only on whether the Multinational Enterprises possess distinguished resources but rather on how it deploys and utilizes such resources in a satisfactory manner. The Dunning formulation of the OLI paradigm perceived FDI as a single transactions that were severely wrong as FDI itself is never a single transaction nor a single step activity. FDI is a dynamic process that entails continued resource commitment (Dunning, 1997). The capability of an MNE to survive in the present turbulent international environment rests on the firm’s abilities during international investment, production, and operations. The dynamic capability view points out that Foreign Direct Investment need commitment besides creating opportunities for obtaining a new set of capabilities (Dunning, 1997). The multinational enterprise becomes a social community through the Direct Foreign Investment that specializes in the establishment as well as internal dissemination of knowledge. The FDI thus formulates foreign alliances as well as assisting the MNE obtain external knowledge. OLI model with O, L and I denoting to Ownership, Location, and Internalization is an eclectic paradigm introduced by John Dunning in 1976 (Dunning 2001; Dunning and Lundan 2008a). Dunning, over a period spanning three decades, refined the pattern several time over. As an analytical framework, the eclectic paradigm became dominant in explaining factors of Foreign Direct Investment (FDI) as well as foreign actions of multinational enterprises (MNEs). The differences between UK and US manufacturing industries in the 1950s and the ripple effect of multinational activity on reducing such variances were fascinating. Ultimately, to explain the scope, geography, and impacts of MNE activities, Dunning identified ownership advantages, location advantages, and internalization advantages as the keys (Dunning 2001). The economic changes experienced fluctuations experienced in the 1980s through 1990s, e.g. the upsurge of international integration and the increase of knowledge seeking investment, saw Dunning polish and spread the eclectic paradigm (Dunning 2001). The key aim however stood at clarifying the global production of all firms in a given country or a group of countries. The OLI pattern principally aims to evaluate the growth of MNE activities: that is who is involved in internalization, location of production, and how international goings-on are organized. Nonetheless, several established MNEs now boast of a wide dispersion of their production activities (Buckley& Casson, 1976). The strategic administration of in-house resources embedded in a variety of subsidiaries remains the main challenge. Entry mode choices and location remain important although the hurdle to tackle by the established MNEs is the necessity for recombination of resource across boundaries, entry modes affiliate locations provided (Dunning 2001). The basis of competitive advantage leans towards a company’s potential to craft and manage a knowledge portfolio. Therefore, recombination of extant O advantages. Dunning’s typology of O advantages fails to shed light on resource recombination difficulties in established MNEs. It does not identify distinctiveness of firms, thus limiting analytical power practical by MNE managers. Furthermore, two foundations critical to established MNE strategic administration, the geographic sources are barely elaborated in Dunning’s typology (Andersen, 1993). The functions of the MNE strategic management in resources combination process despite being highlighted in Dunning and Lundan (2008a) is not fully emphasized. There is, therefore, a need to remedy the Dunning’s electric paradigm with respect to illustrating established MNE behavior and offering direction to senior MNE managers. There has been a proposal of a new typology of O advantages in the current studies. The selection of the established MNE as the unit of analysis and argument that Dunning’s typology of O advantages must be reviewed. Conclusion In conclusion it is true from the preceding discussion that whereas Dunning’s OLI model provides a general paradigm for explaining the determinants of the Foreign Direct Investment, its use in designing an international corporate strategy, as defined by Head, is limited and requires more specific models for the task (Dunning 2001). The LI framework is sufficient to render the electric paradigm a full-blown general theory of internalization of the firm and, also, the OL interaction permits the electric paradigm to deliver helpful techniques for developing a company’s international theory with the effective integration of other specific models as discussed (Dunning 2001). The key purpose at the present contribution is to disseminate traditional theories of internalization with a new version of Dunning’s theme, the OLI model. From the perspective of assuming that there are a sufficient O-advantages, the squabble is formulated with respect to I- and L-advantages. The existence of extinction of I-advantage and L-advantages determines the entry mode and form of operation in a foreign market. From a theoretical perspective, applying the alliances or network as the basis for analysis imply that O-advantage must split up to those solely owned by a firm and the ones shared with some membership of the network. However, the shared knowledge ceases from being a firm’s specific and thus the OLI-model must be worked out for an individual firm and every network engaged in by a particular firm (Agarwal, 1980). Therefore, a trade-off between I-advantage and L-advantage crops in since declined internalization weakens ownership-specific advantages. Isolating O-specific advantages culminates in a leaner model that meets the basic benchmark of internalization. Reference Agarwal, J.P. (1980): Determinants of foreign direct investment: A Survey. Welt-wirtschaftliches Archiv, 11/64. Andersen, O. (1993): On the internationalization process of firms: A critical analysis. Journal of International Business Studies, II/1993 \ Buckley, P. and M. Casson (1976): The future of the multinational enterprise. London. Caves, R. E. (1971). International corporations. The industrial economics of foreign investment. Economica, Feb., pp 1-27. Dunning, J. (1995). Reappraising the eclectic paradigm in an age of alliance capitalism. Journal of International Business Studies, III/1995. Dunning, J. (1997). Alliance capitalism and global business. London Dunning, J. and R. Narula (1996) (eds). Foreign direct investment and government: Catalysts for economic restructuring. London. Itaki, M (1991). A critical assessment of the eclectic theory of the multinational enterprise. Journal of International Business Studies, II/1991. Strandskov, J. and K. Pedersen (2000). Pioneering FDI into the danish bacon industrry. Scandinavian Economic History Review, 3/2000, pp 4256. Read More