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Explain various theories explaining emergence of TNCs in the world economy.

Explain various theories explaining emergence of TNCs in the world economy.

Course: M.Com

1 Answer

The List of various theories explaining the emergence of Transnational Corporations (TNCs) in the world economy.

Hymer’s Market Imperfections Theory:

In 1960 Stephen H. Hymer propounded market imperfections theory. According to this theory a Transnational Corporations (TNC) enjoys certain ownership advantages and controls the foreign direct investment through them. According to this theory the prevailing market imperfections were structural imperfections of a monopolistic nature which arise due to innovation, superior technology, access to capital, control of distribution system, economies of scale, differentiated products and superior management. These factors enable the TNCs to offset the disadvantages of their operations in foreign countries.

Hymer was basically concerned with the market power of the TNCs which restricted the entry of other firms. The market power arises from collusion with others in the industry to avoid competition which results in the larger profits. There is one-way casual link between the behaviour of the firm and the imperfect market structure. The market power is first developed in the domestic country and after the profit margin becomes lower in the home country, the firm interests abroad and controls the foreign markets by its patent rights.

Raymond Vernon’s Product Life Cycle Theory:

In 1966 Raymond Vernon propounded Product Life Cycle Theory. It deals with the evolution of the US multinationals. According to this theory, there are three stages followed in the introduction and establishment of new products in the domestic and foreign markets with emphasis on innovation and oligopoly power as being the first basis for export and later for the foreign direct investment. Product life cycle theory examines the various stages in the life cycle of the products innovated by a particular company.. Following are three stages of product:

1st Stage or New Product Stage: The first stage in the sequential development of the product is the new product stage which emerges in the home country following innovations as a result of intense research and development activities by the company. The product is introduced in the foreign market through export and the innovating firm earns excessive profits both from domestic sales and exports abroad because of its monopoly position. This stage is also known as emerging oligopoly stage.

2nd Stage or Maturing Product Stage: Second stage i.e. maturing product stage arises when the demand in the foreign countries expands and the host country firms began to produce competing products. The home country enterprise is induced to invest abroad for taking advantage of its technology and increasing demand for the product. Since the company specific advantages of the firm controlling the technology are much higher than the local firms, the production in the host country would be cheaper. It stimulates foreign investment in subsidiaries. This stage is also known as maturing oligopoly stage.

3rd Stage or Standardized Product Stage: Third stage i.e. standardized product stage arises when the product becomes standardized and competition grows in the world market. TNCs invest even in the underdeveloped countries where the cost of production is lower. The host country, otherwise, has to import these products from abroad because its own production cost.is more. The foreign investment may take the form of licensing arrangements also. This stage is also known as senescent oligopoly stage.

Product life cycle theory is useful in explaining the expansion of the U.S. companies after World-War II. But it has limited application to the firms going international which were motivated by locational advantages. The locational advantages led to the establishment of assembly plants of automobile in the foreign countries. This theory often applies to firms dealing with consumer products.

Mark Casson’s Market Failure Theory:

John H. Dunning’s Theory of International Resource Allocation states that between them we believe that these theories help to explain the origin of the ownership location and internalization (OLI) advantages created or acquired by firms and strategic management of theirs. A TNC is both multi-activity and engages in the internal transfer of intermediate products across national boundaries. A TNC produces at different points of the value added chain and in different countries. As a result, these firms have to make infra-firm transactions in addition to inter-firm transactions. This implies the some kind of market failure. Market failure is the end-result of the inability of arm’s length transaction to perform efficiently.

Following are three reasons for this situation:

Cross-border transactions: are subject to differences between international and domestic failure i.e. additional risk and uncertainty associated with cross border transactions. Such risks are generally associated with raw materials and high technology industries which spend a heavy amount of development costs. There are risks of disruption of suppliers and property rights being displaced or abused by foreign licenses.

Another reason for transnational: market failure is that market cannot take account of the benefits and costs associated with a particular transaction between buyer and seller which accrue to one another’ parties, but which are external to that transaction.

The third reason for transnational: market failure arises whenever the market is not large enough to enable firms to capture economies of scale because they are facing an infinitely elastic demand curve. Due to nature of demand, firms are not benefited by the economies relating to production, purchasing, marketing, research and development, finance, management etc.

McMonus’s Transaction Cost Theory:

This theory is also known as Internalization Theory. This theory considers the imperfections of the natural type in foreign markets which are different from the structural imperfections of monopolistic nature. According to this theory, TNCs undertake foreign direct investment to raise the efficiency and reduce transaction cost like the cost of information, cost of enforcement and cost of bargaining. The price existing in the foreign countries may not be based on market forces. If the production is left to the agent in foreign countries, the transaction costs may be excessive because of the generations of non-pecuniary externalities by them.

Such disadvantages to the company may be neutralized by adopting a mode of organization which attempts to coordinate the different production units in a hierarchical manner. TNCs adopt a hierarchy for reducing the transaction costs. Internalization is possible in many ways through horizontal investment as well as vertical investment. Vertical investment consists of both backward and forward integration.

Following are some popular methods of internalization:
  • Equity joint ventures.
  • Spot purchases.
  • Long-term contracts.
  • Counter trade.
  • Turnkey contracts.
  • Franchising.
  • Management contracts.

John Dunning’s Eclectic Paradigm Theory:

Eclectic Paradigm Theory was developed by John Dunning in 1979 as an attempt to synthesize the other theories and approaches based on the company specific advantages, internalization advantages and country specific advantages. Company specific advantages are ownership advantages such as the superior technology access to capital, organizational and marketing skills, trade marks, brand names, economies of scale and product differentiation. Country specific advantages are locational advantages such as natural resources, efficient and skilled low cost labor, trade bathers, etc.

The main propose of the eclectic paradigm is to provide an analytical framework to the analyst so that he could choose the most suitable approach for his investigation. The eclectic paradigm provides merely a comprehensive framework. It does not specifically high light the advantages of competitiveness in the foreign countries. This theory does not take into account any single TNC theory on priority basis. It points out the circumstances which the investigator should take into account in deciding which theory would suit his needs.

February 7, 2019