Eclectic theory

The eclectic theory, associated with Dunning (1981), attempts to explain a logical link between the international allocation of resources and the exchange of goods between countries. In other words, this theory makes the case for an integrated approach to international economic involvement based on the advantages of both a country's location and a company's ownership. Location-specific advantages, such as natural resources and low labor costs, are advantages that are available only or primarily in a single location. Ownership-specific advantages, such as capital funds and technology, are advantages that favor MNCs over local companies. The eclectic theory implies that location-specific advantages favor a host foreign country, while ownership-specific advantages favor an investing firm. Thus, the eclectic theory helps to explain cross-country differences in patterns of MNCs' international involvement.

When a company expands its operations beyond national borders for the first time, it tends to exploit a foreign country's markets through exports. A company favors investment in a foreign country only if it is most profitable for the company to internationalize its advantages in that country. Dunning argues that a company is willing to invest in overseas production facilities if the company has the following three kinds of advantages:

1 Ownership-specific advantages: this is the extent to which a company has tangible and intangible assets unavailable to other firms.

2 Internalization advantages: it is in the company's best interest to use its ownership-specific advantages rather than license them to foreign owners.

3 Location-specific advantages: the company will profit by locating part of its production facilities overseas.

It is important to note that empirical tests of the eclectic theory show that the major part of foreign direct investment is made by large, research-intensive companies in oligopolistic industries. These companies find it profitable to invest overseas because they enjoy both location and ownership advantages.

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