New Institutional Economy Theory - Literature review Example

In 1976, Hymer developed this theory with the intention of explaining the firm's behavior in a non-competitive business environment (Agénor & Aizenman, 2014).  For an organization to be involved in FDI, the unique advantage to the domestic country’s firms should be established and this includes the technology advantage as this is integral in the modern globalized economy. With the market disequilibrium reported in the economy, FDI will play a role in the transition amongst the different market segments and this will be essential in achieving the desired market equilibrium in the long-run.

Also, the theory explains that the market imperfections reported in the economy following information asymmetry and the barriers that exist on the entry of such firms. There is the possibility of market disequilibrium as the involved economies are concerned with the protection of the economy against competition from the foreign and established firms. In most cases, disequilibrium in the economy is often reported in the factor markets including the labor markets in which FDI inflows are reported from the countries characterized by the high cost of labor to those that have a low cost of labor.

According to Choi & Yu (2013), labor is a key factor of production that every company has strategized in minimizing towards reporting high revenue outlay, which necessitates a competitive edge in the industry. As such, market imperfection theory supports FDI in the developing economies as they will be assured of cheap labor and this will increase revenue outlay for the company. The instability in the political and economic situation of the country has an implication on the labor market, and this can be instrumental in affecting the competitiveness in the dynamic industry.

The changes in the economic conditions affect the cost of labor, and this either negatively or positively impacts the revenue outlay of the company. The other imperfections that can be reported in the FDI implementation are the specialized knowledge and trade barriers. The theory provides that the technical expertise that the foreign investors bring to the economy can have an implication on the foreign direct investment (FDI) initiatives.  The trade barriers that characterize an economy have an impact on the FDI activities that are reported in the region.

The New Institutional Economy (NIE) theory provides an assessment of the implications of the institutions on the overall economic behavior in the region. According to Lok (2017), the NIE theory determines the institution's behavior and its implications on the FDI inflows. The institutional environment provides a framework in which rules and regulations are developed in reducing uncertainty. In neoclassical economics, institutions are discussed on the basis of constraints that are developed in the economy, and the same situation is explained by the NIE theory (Lok, 2017).

Institutions are seen as the constraints to the FDI inflows. According to Meador & Skerratt (2017), the restrictive function of the organization is a collective measure in which the legal environment and the rules that are set are essential in understanding the legal environment and the prevailing property rights in the economy. The efficiency of the common law provides the contrasting views in which the relationship between legal realism and NIE are provided and the mechanism in which the development in the economy can be realized.

Lok (2017) outlines the role of social conventions in coordinating the legal system formulation and the level of FDI inflows reported in the economy. The social institution is considered as a regularity that the different members of the society have agreed and the specification of the behaviors of the members. The regularities that are reported in the economy provides a timely framework in which the competitiveness and the interaction of the different agents can be reported in the economy.