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The Determinants of International Production Author(s): John H. Dunning Source: Oxford Economic Papers, New Series, Vol.
25, No. 3 (Nov., 1973), pp. 289-336 Published by: Oxford University Press Stable URL: http://www.jstor.org/stable/2662317 . Accessed: 23/05/2013 01:24
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THE
OF INTERNATIONAL DETERMINANTS PRODUCTION'

By JOHN H. DUNNING
Introduction
THERE are few branches of economic analysis which are not directly relevant to an understandingof the origin and growth of multinational enterprises(MEs). The subject is obviously of interestto those concerned with the resourceallocative activities and financialmanagementof firms, and with the theory of industrial organization. Since their operations straddle national boundaries,and involve trade in both goods and factors of production, they come within the scope of international economics; they are ofnew skillsand technologies, and as vehiclesforthe transference no less pertinentto the theoryof economic development. The sharingof oftheiractivitiesbetweenthe countriesin whichthey the costs and benefits operate raises complex and fascinatingissues for the welfareeconomist. production,and marketoftheirprocurement, The geographicalflexibility ing strategiesadds a new dimensionto the theoriesof industrialrelations by, and collectivebargaining;whiletheiroperationsare not onlyinfluenced fiscal used by a of and policies but help to fashion, whole range monetary to advance economic and social goals. national governments because, in interpretI make these observationsby way of introduction, ing the various explanations of the origin and growth of international business, one is very consciousof the particularinterestsof the researcher. This is shown both in the type of questions asked, and the approach and invest overtechniques used to answerthem. The questions 'why do firms locate theirforeignoperations?' and 'what deterseas?', 'where do firms mines the amount and composition of international production?' pose similar,but not identical issues. Each is concernedwith the behaviour of firms,but while the firstdraws on the techniques of micro-investment and the thirdneeds to the location theorist, theory,the second is ofinterest a knowledge of internationaltrade and industrial organization theory. Moreover,each ofthe questionsmay be tackled froma positive or a normative viewpoint; and with sectoral, national, or cosmopolitan interestsin mind. The purpose of this paper is two-fold; firstto survey and critically evaluate the attempts so far made to answer the general question 'why 1 A shortened version of this paper was presented to a conferenceon The Growthof Multinational Enterprisesorganized by Gilles Bertin at Rennes, France, in Sept. 1972.
4520.3 U
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internationaldirectinvestmentand production?' and, second, to suggest some possible lines for furtherresearch, illustratingfrom data recently in the U.K. published about the operations of U.S. affiliates
The issues involved

have What, then,is the subject forexplanation? Basically, most writers which of enterprises been concernedto explain the growthand significance activities in more than one country, operate and controlincome-creating activitiesof ofthe foreign or,morespecifically, the growthand significance such companies. It is when one startsto translatethis generalrubricinto Precisely at what point operationaltermsthat one runs into difficulties. does an enterprisebecome 'multinational'? What does one mean by activities? 'control'? What exactly are income-creating The ME has been variouslyinterpreted in the literature(Aharoni,1971). Definitionsrange fromthose which embrace all firmswhich operate and activities in more than one country(Brooke and controlincome-creating Remmers,1970; Dunning, 1971) to those which would include only those whichoperate a commonmanagementand operationalstrategy enterprises and domesticoperations(Perlmutter, 1969; Behrman, towardstheirforeign e.g. the number of 1969). Others introducemore pragmatic constraints, in whicha firm oftotal countries operates (Vernon,1972) or the proportion accounted forby theirforeign activities(Bruck sales,assets,or employment approach which interand Lees, 1966). There is also the totally different in termsof the geographicalspread of ownershipor pretsmultinationalism controlof equity capital (or capital employed). While respectingthe views I have long favoured a broad rather than a narrow of the particularists, are bound to be of the ME, partly because all other definitions definition and partly because I do not considerthe attributesof the ME arbitrary, etal. are necessarilyunique to such enterprises;cf., stressedby Perlmutter e.g., multi-regionalnational or international trading enterprises. The betweenthe geographicaloriginof capital and of the ownership distinction of productionfacilitiesis best overcomeby placing the appropriateadjective between the words 'multinational' and 'enterprise' (Dunning 1971). again vary from Second, as regardsthe question of control,definitions and associated companies of MEs in which thereis any includingaffiliates financialstake to those in which there is a 100 per cent equity holding. simply because there is no such Here, too, there is no purist definition, of controlof decision taking, eitherof its amount or its extent. definition a 51 per cent ownershipof equity But this much can be said. Since, first, and, second, an capital ensuresthe powerof controlover decision-taking, in whichMEs have overwhelming proportionof the capital of the affiliates
J. H. DUNNING
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a stake is financiallycontrolledby them,' we would not go far wrongby consideringall companies with a foreigndirectinvestmentstake as MEs. Third,the interpretation and measurement ofincome-creating activities. These include all activities in which there is a capital stake of some kind involved. This immediatelydistinguishesmultinationalproducingenterprises frommultinationaltradingenterprises. Again, in practice, the line between settingup one's own sales outlet and using a local distributor may to draw, but this need not greatly concern us, as the great be difficult majorityofMEs are engagedin the productionofgoods or financialservices and most of the currentdiscussionabout theiroriginsand effects is to do with these companies,ratherthan with wholesalingor retailingventures. ofthe economicactivitiesofMEs raises no new concepThe measurement tual problemsand, in most cases, the indicator chosen will be determined by the data available and the purpose of the exercise. In general,output measures are preferable to input measures,forthe simplereason the latter are usually expressedin termsof one input, e.g. capital stock,investment etc. Outputindiceson the otherhand, pose theproblem flows, employment, of whetheroutput should be gross,i.e. values or sales, or net,i.e. sales less purchases fromother firms. In fact, most published statistics of international production are of sales rather than net output; these tend to ofMEs or theiraffiliates exaggeratethe directeconomiccontribution to the gross national products of the countriesin which they operate. This last point raises two others. The firstarises when one asks the question 'fromwhose viewpointare we measuringincome-creating activities?' From the viewpointofMEs, theirown sales, or net output or profits may be the appropriateindex. From the viewpointof countriesin which theyoperate,the contribution theymake to the grossnational productmay be the chief (economic) consideration; this includes not only their own whichtheyhave on the net output of othereconomic output but the effect agents in the economy. But the value of this contribution depends on the assumptions made about what would have happened in theirabsence and, in any case, it may be reasonably argued that since it is individual firms that take the decisions about theiractivities (albeit in responseto signals it is the factorswhich influence these decisions which fromgovernments), are the relevantones. But in lookingat the appropriatepolicies forgovernof theirbehaviour may ments to pursue towards MEs, the external effects be equally important. directinvestment and arisesbecause to foreign The secondpointis specific
1 For example, according to the U.S. Department of Commerce,in 1966, 95 per cent of the earningsand 93 per cent of the net capital flowsof U.S. foreign affiliates were accounted for by affiliatesin which there was a 51 per cent or more U.S. equity stake. Similarly,in. 1965 91 per cent of all U.K. direct investment,outside oil, banking, and insurance,was 51 per cent or more U.K. financed.
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the factorinputs of MEs are sourced fromboth (a) the countriesin which they operate and (b) othercountries. The ratio of (a) to (b) will determine that part of the value added by a particular affiliate fromwhich the rest benefits. This means that, just as expressingthe activity of the enterprise in termsof a singleinput may underestimateits contribution, of an affiliate so assessingit in termsofgrossor net output may overstateits contribution to theenterprise. If,forexample,a ME ownsone-half oftheequity capital of its affiliate, thenthe ratio of the sales to its affiliates to the total sales of the will be twicethat ofthe ratio ofthe profits enterprise earned by the affiliate to that of the enterpriseas a whole, assuming that the profit/sales ratios and taxation rates are the same forall the operatingunitsof the enterprise. Once again, it depends on what questions one is seekingto answer,but it is worthemphasizingthat identifying and measuringactivities of MEs is not as straightforward as it may appear to be. In practice, the matter is often settled by the data available and the economisthas to cut his coat accordingto the clothgiven him,or obtained by himself! And the researchso fardone on the growth ofthe multinational this constraint. Broadly speaking, economists enterprise stronglyreflects have obtained theirdata fromthreesources. First,frominformation published,mainlyby governments ofhost and investingcountries, on the stock or flowof inward and outward directinvestment. Due mainlyto different of governments, the form,coverage,and reliability reporting requirements of these data vary enormouslybetween countries,and withina country over time,and theyare rarelydirectlycomparable. Valiant attemptshave been made by Polk (1971), Behrman (1969), and Rolfe (1969), to construct a world matrix of the value of international direct investment and/or production,but none has been completelysuccessful.' As far as investing countriesare concerned,the most comprehensive data are those published by the U.S. Departmentof Commerce.2These include investment, output, and income data for 1966 and 1970, broken down both by countryand industry. U.K. statistics are confinedto a fairly detailed geographical breakdown of the capital stake and investment flows; the industrial breakdownis verybroad. There are also quite reasonable data on outward direct investmentfor Canada, Australia, and latterlyJapan. Of the host countries,Canada, Australia, the U.S., and U.K., Sweden, and Belgium, and some of the l.d.c.s., e.g. Argentina,India, Ghana, Nigeria, Malaysia,
1 The work of Judd Polk deserves mention in this context. He defines(U.S.) production work togetherwith foreign abroad as 'productionin which U.S. management and financing factorsof production'(Polk, 1971, p. 9); or, even more succinctly,'product emanating from foreigninvestment'or the 'product profitsof an investmentactivity abroad'. His estimate of the value of this componentof world productionin 1969 was $450 million,or 15 per cent of gross world product, and that since 1950 this has been increasingat a steady rate of 10 per cent a year (Polk, 1971, pp. 5 and 8). 2 Usually in the Survey of Current Business or in special supplements to this periodical.
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Korea, the Phillipines, Taiwan, and Indonesia provide reasonably good statistics.' Major surveyson the extentand patternofSwedishand German foreigninvestmentsare currently being undertaken. The second formof data is that derived fromfield work carried out by research institutionsor individual researchworkersin pursuance of a specificproject to do with foreigndirect investmentor the ME. Most of these projects have taken the formof countryor industrycase studies,2 although some have been specifically concernedwith the determinants of investment. Again, the quality of the data varies as, in most cases foreign the investigatorshave had to relyon the good offices of firms, but forsome of the less-well-documented countries,particularlythe l.d.c.s., and for a more detailed breakdown of industry statistics, these studies usefully statistics. supplement (and sometimesimproveupon) the official is that being gradually amassed in data The thirdsource of information banks and is based largely on statistics related to individual companies. The first ofthesewas establishedat Harvard and supplied much ofthe data forthe studiesled by Raymond Vernon (1972); morerecently, GillesBertin at Rennes. In spite ofthe interpretative has set up a European counterpart I believe that these data banks have much to commendthem. difficulties, Already, usefulprogresshas been made by internationaland government agencies, notably U.N.C.T.A.D., O.E.C.D., and E.E.C., and U.S. Tariff Commission,by researchinstitutions, e.g. Foreign Policy Research Institute at Pennsylvania and CentreforMultinational Studies at Washington and by such organizations as the International Chamber of Commerce and Business International. Various internationaltrade union secretariats are also actively gatheringmaterial. One feels that the time is rapidly approaching for some rationalizationof data collection, partly to avoid and partlyto reduce unnecessaryduplicationofresearchand clericaleffort, the work on individual MEs, who, after all, are the main providers of information. I will returnto this point later in the paper. But one practical difficulty which make up the should be mentionedhere. The numberof enterprises MEs great bulk of foreigndirect investmentis small. The largest fifty probably account forone-halfof the total internationaldirectinvestment and an even higherpercentageofinternational productionin the world; the next largestfifty account forup to another 25 per cent. When one comes to break down these operations geographicallyand industrially in any meaningfulsense one is soon dealing with a handful of companies. The then becomes very real, and this may well possibility of identification
1 For a comprehensive analysis of foreigndirect investmentin Asia and the Far East see United Nations, 1971. 2 See particularly those mentioned on p. 21, May and Arena (1971), FIEL (1971), and United Nations (1971).
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THE DETERMINANTS
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impose the ultimatelimit to sophisticated econometricwork in this field. This point is furtherunderlined when one comes to classifyMEs by the operationalstrategies theypursue, and/orothervariables, e.g. by activity, intra-group exports,size, age, etc.; one is soon down to a fewobservations in each cell of the matrix which raises conceptual as well as identification problems. So much by way of introduction. We now turn to examine the work so far done on identifying the factors influencing the origin and growth of internationalproduction. We shall mainly concentrate on the positive approaches to the subject and discuss these under six main headings. 1. The survey approach One approach to explainingthe extent and characterof foreign business the reasons operationshas been to ask the companiesthemselvesto identify fortheirbehaviour. Usually, this approach has confined itselfto analysing the initial decision to produce abroad, and, more often than not, the questions have been formulatedin the most general terms,e.g. 'what are the main factorswhichinfluencedyour decision to invest overseas?'; and rarelydoes any guidance seem to have been given to the respondentsas to the questions asked. Because of this, the surveys assumptionsunderlying have produced a wide range of answers,which reflect as much the respondents' interpretation of the questions as the determinantsof the investment decision. There were several surveys of this kind in the later 1950s and 1960s (Barlow and Wender 1955; National Industrial ConferenceBoard, 1961; Robinson, 1961; McGraw Hill, 1961; Behrman, 1962; Basi, 1966; Hakam, 1966; Kreinin, 1967; Kolde, 1968; Hogan, 1968), and frequently, too, in broader based works on foreigndirectinvestment(Safarian, 1966; Brash, 1966; Brooke and Remmers,1970; Deane, 1970; Daniels, 1971; Andrews, 1972; Forsyth, 1972), questions of this type have been asked. Some of and otherson means directinvestment, thesefocusedon the goals offoreign of achievinggoals, but most did not distinguishbetween the two. In the main,the resultsofthe surveyswerepresentedas a tabulation ofthe reasons listedby therespondents in the formovingabroad, or to particular countries sample, in Basi's analysis, a three-point'importance' scale was used; but were mostlythe only evaluation was by the times particulardeterminants mentioned,the number of which ranged fromnine in the Kolde study to in the Robinson study. No attempt was made to classifythe twenty-five resultsby types of economic activity,or by country;although some of the studies concentratedon particularregionswithincountriesor areas (Johns and Brash (Australia), Forsyth (Scotland), Kreinin (Europe), Hakam (Nigeria)).
J. H. DUNNING
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It is clear that these studies can, at best, do little more than identify and perhaps rank by importancethe sort of factorswhich businesses take into account in establishing production units abroad. At worst, they can be thoroughlymisleading. Quite apart fromthe confusionbetween goals (e.g. increased profitsor share of market) and factorsaffecting the achievementsofgoals (e.g. transport costs,marketgrowth, etc.) the reasons on each other, citedby firms weresometimesinterdependent e.g. lowercosts of production and higherlabour productivity;in some cases the reasons cited were quite specific, e.g. the existenceof local engineering facilities, or to match a rival's investment; in others,theywereverygeneral,e.g. diversification,inflation. Moreover,as we have said, there was little attempt to classify types of foreignoperations,and only a casual acquaintance with the literaturesuggeststhat the determinants of investmentvary so much with the typeof investment;cf. the reasons forupstreamand downstream investment,that any generalizationsare not very helpful. As Table I illustrates,almost without exception, the studies stress the host government's attitudeto inwardforeign investment, politicalstability, and the prospectsof marketgrowthas the most importantconsiderations prompting foreign activities;next in ordercomethefearoflosingan existing market,the likelihood of exchange rate fluctuations, limitationsimposed on foreignownership,and barriers to trade.' Only a minorityof firms appear to have been enticed abroad by lower productioncosts; neitherdo savings in movementcostsloom large in theircalculations. But again, the studies do not tell us the way in which these determinants may vary with geographical or industrial composition of the investment. In summary, between they may be criticized,partly because they fail to differentiate motives and determinants, the assumppartlybecause theydo not identify the answersgivenby firms, tions underlying and partlybecause no attempt is made to normalize for differences in the characteristicsof firms(or in a generalized countries). Certainlynone of them take us much further theory of internationalproduction,or help us to understand the determinants of new investmentonce the initial locational decision has been made. efforts have been made to improvethe methodology More recently, ofthe survey approach, both by giving respondentsa clearer conception of the and by suggesting type of variables it is soughtto identify, ways in which they mightbe evaluated. Stobaugh (1969a) for example, makes use of a matrix which identifies two main groups of variables which gauge locational attractionsto companies. For example, he relatesproduct-related influences, technologicaland
1 For an interesting examination of the reasons for establishing foreignmanufacturing plants by U.S. firms priorto 1900, seeVernon (1972) (Table 3.5, pp. 72-3) and Wilkins (1970).
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THE DETERMINANTS
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and economies lifecycle pattern,cost structure, marketingcharacteristics, influences, of scale to country-related e.g. marketsize, investmentclimate, nations.Schollhammer major exporting and distancefrom local technology, influences, (1972) adds a third group of influences,viz. company-related scope of internationaloperationsmanagement strategy. e.g. size of firm, The same authors and Piper (1971) have also suggestedschemes forthe evaluation of these variables. Stobaugh (1969b), for example, sets out ranges of marks which mightbe given for each particular environmental variable (attitude to capital repatriation (0-12), extent to which foreign stability(4-20), etc.), whichare then ownership is allowed (0-12), currency assigned by firmsaccording to some redefined criteria. The marks are attraction,or investment then aggregatedand an index of environmental climate, obtained. Schollhammer(1972) in a study of 140 American and European MEs asked corporate executives involved in making location influences(classifiedinto decisions to rank seventy-eight country-related nine broad categories,e.g. economic,legal, geographical,political,labour, tax, etc., factors)on a scale from1 (ofno importance)to 4 (veryimportant). those of earlier surveys. The two most His findingsbroadly confirmed importantindividual location factorswere existingmarketsize and anticipolitical,supply,and but oftheninebroad groupings, pated marketgrowth, tax considerationsoutranked the rest. but they also have Such schemesas these have theirobvious attractions, theyalmost always set the same theirdrawbacks; among the latterare first standards for all types of investmentand in all countries; second they assume that over the life of the plant, the investmentclimate will remain unchanged; and thirdthey assume that individual locational determinants can be separately and independentlyevaluated. We conclude: while the survey approach may be helpfulin identifying the factorswhich influenceinternationalproduction,it can do little more in evaluating particular than this. In the past, it has not been satisfactory and even attemptsto use a rankingprocedurehave goals or determinants, to take account ofdifferent types been oflimitedvalue because ofthefailure between so far the have None of investment. distinguished of surveys the establishmentof foreign productionunits fromthose factorsaffecting increasesin international production. Finally, all too frequently influencing they have rarelydefinedthe formof the involvementof companies abroad is taken as the dependentvariable it is not clear whether (wheninvestment or investment-controlled). this means investment-owned 2. Capital theory The second approach to the study of 'why internationalproduction?' focuses attention on one factor input, viz. capital, or changes in capital,
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viz. investment,and is essentiallyan extensionof received capital theory. almost all the empiricalwork done in Mainly because of data constraints, this area has been on the behaviour of U.S. MEs. In most cases, the U.S. is taken of U.S. foreignaffiliates share of the capital stock, or investment, as the dependent variable, but occasionally the totalplant and equipment i.e. investmentin fixedassets, is used. expenditure of affiliates, The traditionaltheoryof internationalcapital movementsassertsthat in the levels of interestrates such movementsarise because of differences money capital flowsacross the between countries. Under these conditions, exchanges, if the marginby which the expected yield exceeds the cost of capital is greaterthan that of projects at home. Until the mid 1960s, this relationshipwas thought,by most economists,to explain movementsin investmentfairlywell (Mundell, 1960; Kenen, 1963). Since then, portfolio partly as a resultof developmentsin the theoriesof investmentbehaviour and portfolio distribution, a new view has emergedwhicharguesthat,while the allocation ofthe stock ofassets held at home and abroad depends on the level of interestrates and risk evaluations, changes in this allocation, i.e. willdepend on changes in interest rates (Branson, 1970; Floyd, capital flows, 1969). Accordingto this view, an increase in foreigninterest rates will effect. First, it will cause a shiftin the stock of portfolios have a two-fold effect, which towards foreignassets; this is called the so-called stock-shift will vary interalia with the size of the portfolioand the amount of change in the interestdifferential. Second, therewill be a reallocationofportfolios at the margin towards foreign assets-the so-called 'continuing flow' of capital effect.Wherethe lattercomponentis small,the supply-elasticity with respect to changes in interestrates between countriesis likely to be substantial only in the adjustment period. For there to be a permanent redistribution of capital movements between countries their relative interest rates must be constantly changing. This new view is generally supported by the empiricalstudies of the last fewyears (Branson and Hill, 1971), although the period of stock adjustment is now being shown to be somewhat longerthan was first thought. It is generally accepted that models of this kind, designed to explain internationalflowsin portfolioinvestment,can only partiallyexplain the offirms or that part ofit financedby direct internationalcapital formation investment. This is mainlybecause, unlikemovementsin portfolio foreign capital, which are essentiallyfinancialtransactionsbetween independent involves no change in ownership. directinvestment lendersand borrowers, It does, however, involve the transmissionof other factor inputs than money capital, viz. entrepreneurship,technology, and management of expertise, and is likely to be as affectedby the relative profitability countriesas that of money capital the use of these resourcesin different
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(Stubenitsky,1970). Put anotherway, the models are inadequate because intheyassume that the transactorsengagedin the activityofinternational (Learnerand Stern, vestmenthave similarbehaviouralcharacteristics 1972). Nevertheless, recent research on the origin of international financial and real capital flowshas provided usefulnew insightswhich have a direct behaviourofMEs (Spitaller,1971; Stevens, 1972). bearingon theinvestment Harry Johnson(1966), for example, makes the useful distinctionbetween movementsin capital which occur in responseto interestrate differentials and those which are generated by the expectancy of higherprofits. At a macro-level,it is this latter type of movement that Borts and Kopecky (1972) argue can best be explained by the same factors which explain economicgrowth,e.g. increasesin population, technologicaladvances, the in the termsof trade between exports and importedcapital improvement and that it is not norgoods, the savings rate, and the capital coefficient; factors to explain whyorhow capital mallynecessaryto introducemonetary transfersoccur. Monetary variables may affectcapital movements but on the only in so far as an excess demand forliquid assets has an influence excess demand forgoods. and represents the The alternative approach is more micro-oriented main stream of thinkingon the subject. This is directedto extendingthe theoryof domestic corporate investmentto the internationalactivities of firms. There are two main strands to this approach. The least well investmentdecision as developed is that which looks at the firm'sforeign distribution.Following attemptsby an extensionofthe theoryofportfolio Grubel (1968), Millerand Whitman (1970), and Levy and Sarnat (1970), to investmentacross national boundaries explain the distribution ofportfolio using a stock adjustment model of the Markowitz (1959)/Tobin (1958, 1965) variety, Prachowny (1972) and Stevens (1969a) set out to test whetheror not firmsallocated their directinvestmentexpendituresso as to maximize a utilityfunctionpositivelyrelated to expected returnsand negatively related to risk. Their results were inconclusive, particularly when disaggregateddata were used. Cohen (1972), on the otherhand, has demonstratedthat large U.S. corporationswith more extensive foreign activities tended to have smaller fluctuationsin their profitsduringthe developed by Smith 1960s. Finally Mellors (1973), using a technique first ofconglomerate and Schreiner(1969) to explain the domesticdiversification firms, has demonstratedthat the geographical allocation of direct investin responseto post-taxrates of return, ment by U.K. firms, provides some supportto the portfoliomodel. More extensive have been the attempts to apply various models of domestic capital formationby businesses to explain foreigninvestment.1
1
For a survey of some of the recent literature,see Stevens (1973).
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In particular, two main lines of research may be mentioned. The firstis an extension of the neo-classical theory of real investment,and assumes the maximization of the market value of assets to be the goal of firms. Here the most popular model is that developed by Jorgenson(1963), in which investmentis viewed as a gradual adjustment of a firm'sactual capital stock to its desired level, i.e. K* = ap, Q1/c, where KE4 desired level of capital stock (at time t), pt product price (at time t), Qt is expected output,c, = the rentalpriceof capital (whichin turnis a function of the price of capital goods and its rate of change, the cost of capital; the depreciation and tax rates), and 'a' is a constantfromthe Cobb-Douglas production functionmeasuring the elasticity of output with respect to capital. This is a modified versionofthe flexibleacceleratorexplanation of investment,which in most tests has out-performed the simple accelerator model, liquidity and cash flow models, and security valuation models (Stevens, 1972). Therehave been numerousstudieswhichhave examinedthe determinants of foreigninvestmentover the last five years. Again, it is convenientto classify these into two groups. The firstis illustrated by the work of Stevens (1969a and 1972), Moose (1968), Severn (1972), Popkin (1965), Kopits (1972), Richardson (1971 and 1972), and Kwack (1973). Each of these strongly supportsthe standard investmenttheoryby demonstrating that expenditureby U.S. firmson foreignplant and equipment is highly or some measure of correlatedeitherwiththe sales of U.S. foreign affiliates output for the area of industryin question. Severn, forexample, used a model (theU.S. and therestofthe world)to explain differences two-country both in the specificationof domestic and foreigninvestmentfunctions, and the distribution of corporatefundsbetweenhome and foreign uses. He concluded that subject to a liquidity constraint,investmentwas strongly correlated to changes in sales in both cases. He also asserted that MEs to national boundariesand that,eliminatallocated fundswithoutreference and domesticinvestment, the two were ing factorscommonto both foreign at least partially substitutable and interrelatedthrough the financing affiliates mechanism. Popkin, in his study of U.S. manufacturing (1965), rates and otherfinancial variables weremore claimed that therelativeprofit important than market structureor technological factors in explaining variations in the behaviour of firms. Stevens (1972), using similar data, theorem(1958), derivedequations and an extensionoftheModigliani-Miller which,interalit, related plant and equipment expenditureand changes in currentassets to the presentmarketvalue of firms, and also financialflows to the same goal and that ofexchange loss minimization. He foundthat all equations explained past data quite well. In his study, Kwack (1973) identifieda negative correlationbetween U.S. interestrates and foreign
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investment but, like Stevens (1972), concludedthat the voluntaryrestraint programme, aimed at improving theU.S. balance ofpaymentswas statistically insignificant. by Richardson (1971 and 1972) took these discussions a stage further between different types of foreigndirect investment. In distinguishing particular,he argued the need fora separate theoryto explain investment in new ventures,the main goal of whichis likelyto be marketpenetration, or growthgoals of establishedventures. ratherthan the profit-maximizing He also considered that domestic-typetheories were less successful in explaining the investment policies of the affiliatesof integrated multinational firms, which were more likely to be geared to a global strategy, than in the case of independentaffiliates, wherean 'every tub on its own he bottom' type of policy was the usual practice. In his contributions, necessaryto the accepted variables to suggestedthe kind of modifications explain the optimal capital stock of each of these types of foreigninvestment,althoughhe did not attemptto put these to the test. His, however, is perhaps one of the most rewardinglines ofresearchin that he recognizes of MEs will vary accordingto the type both the motives and determinants of foreignoperation, a point to which we shall returnlater. Most of the research so far mentioned accepts that there are certain to such investfactorsaffecting whichare specific foreigncapital formation that between ment,althoughHerringand Willett(1973) have demonstrated 1957 and 1969, U.S. plant and equipment expenditures at home and abroad were significantly correlated. Other studies have attempted to isolate some ofthese,e.g. Cairncross(1973) and Herringand Willett (1972) control over capital exports, Kopits (1972) and Mellors (1973) the tax variable, Stevens (1969b) and Heckerman (1969) exchange risks, and is to test statisticHorst (1972) and Jud (1973) tariffs.Much moredifficult of non-quantifiable variables such as the investment ally the significance climate,which,as we have seen (pp. 296-7) businessmenconsiderto be an influence on theirinvestment plans. One way out ofthis dilemmahas been suggestedby Miller and Weigel (1972) who argue, on the lines of Aharoni shouldbe regardedas (1966), that decisionsabout the locationofinvestment a two-stagediscriminant stage, locations are classified process. In the first as 'suitable' or 'potentially unsuitable', on fairlybasic grounds, size of barriersto exports,investmentclimate,etc. In market,priorinvestment, the second stage detailed calculations are made of the expected economic of the locations consideredpotentiallysuitable. The fact that profitability the variables included in many models may not hold up well when predictstage rejectionshave ing all decisionsmay be due to the fact that the first already been made, but on non-economicgrounds. The second group of studies on investmentbehaviour have sought to
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in particulargeographical capital formation explain movementsin foreign areas; the writingsof Bandera and White (1968), d'Arge (1969), Scaperlanda (1967), Wallis (1968), Scaperlanda and Mauer (1969, 1971, 1972), Schmitz and Bieri (1972), all dealing with U.S. direct investment in Western Europe,' are some examples. Most of these, using either time series or cross-sectionaldata, relate absolute amounts of investment(or rates, size capital stake), or sharesof investment(or capital stake) to profit of markets,growthof markets,tariff rates, and some kind of trend and/or slope shifting variables; the 1968 Bandera and White study included an international liquidity variable. The cross-sectional studies strongly support the hypothesisthat U.S. investmenthas been directed most to and countrieswith the fastest rate of growthof GNP, with profitability othervariables, includingtariffs, being a secondary consideration. On the the formation ofthe E. E. C. otherhand, thereis littleevidencethat,in itself, had a substantial effect on the level or directionof U.S. investmentflows; although much depends on the precise specificationof the relationships, the level of disaggregation,2 and the years for which the comparison is made. The time series data lend support to the cross-sectional data when the capital stake is taken as the dependent variable (Bandera and White, 1968). Again, in both cases, the marketvariable showed up betterthan the profitrate. What conclusionscan be drawn fromthese studies? In my view, none of them can take us faralong the way to understanding'whyinternational production?' This, I think,is chieflybecause their attempts to explain either foreigncapital formationor movementsin capital across national boundaries evade the more interesting questions to do with international production. The studies take, as given, the value of variables which, themselves,need explaining. Anticipated profitsare a good illustration. These are almost always expressedin termsofthe profitability ofthe foreign affiliates.But not only may these be a very imperfectindication of the to the investingenterprise(Reddaway, 1968 contributionof the affiliate and Vaitsos, 1972) but to explain direct foreigninvestmentin terms of profitabilitybegs the question 'why that profitability?',the answer to which is bound up inter alia with the competitive position of foreign affiliates and exports. vis-a-visindigenous firms In otherwords,the questions asked by capital theorydo not get to the heart of the matter. The concernof this approach is not to explain foreign investmentor capital formation per se, but that,assumingthisto exist,how far is its allocation influenced by profit rates and marketgrowth? This is
1 For an analysis of the determinants of foreigndirectinvestmentin the U.S. see Daniels (1972). 2 Compare the significance of the tariff variable with that suggested by individual industry studies.
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a perfectlyvalid and legitimateinterest,and when related to the same does point to some interesting differences variable fordomesticinvestment, in the behaviour of firms(Richardson, 1971). But we are little wiser in understandingwhythis is so. Moreover,all the studies are, to some extent,deficient in their choice of explanatory variables and we have said that investment,particularly investmentfinancedby a particularsource,is not necessarilya good index of the activity of firms,as it underestimatesthe importance of labourintensivefirms.Of the independentvariables, the rate of profit earned by affiliates may inadequately express their contribution to the organization ofwhichtheyare part,particularly wherethereis a good deal ofproductor process specialization between affiliates, and intra-grouptrading at other than arm's-lengthprices. Moreover, the more vertically or horizontally integrated an ME becomes, the less significancecan be attached to the marketsize or potentialofthe country in whichproductionis located. This especially applies to those enterprises which practise a policy of global or regional,horizontalor vertical specialization, e.g. the Philips and I.B.M.s ofthisworld. They are not primarily dependenton marketsofthe countries in which they operate because their decisions will be influencedby other considerations. Finally, the data on whichthe analyses ofinvestment are based are rarely disaggregatedby typeofeconomicactivity. Because ofthis,it is impossible to assess the extent to which different types of overseas operations are influencedby different variables. This, in fact, one knows to be the case and the importanceofthe profit as the contribution (or sales) ofthe affiliate to the goals of the enterprise may be small. The objective of foreignsales and marketing venturesis primarily to advance the exportsofthe investing affiliate company; even a manufacturing may spur the exports of related goods fromits parent company. (In 1966, U.S. affiliates importedgoods worth $6 1 billion fromthe U.S.-about 11 per cent of theirtotal foreign sales); similarlyan investmentin raw materialsmay be made to safeguard supplies to the rest of the organization; while Reddaway (1968) and Dunning (1970) have observed that the feedback of knowledge resulting froman investment in a technologicallyadvanced countrycan more than compensate forany low profitsearned.
3. The trade approach

The third approach to 'whyinternationalproduction?' is that of interwithreceivedtheory national economics,and stemsfomthe dissatisfaction to explain recenttrendsin the level and compositionof trade. It is worth
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emphasizingthat, in the classical model of static comparative advantage, there is no room forthe ME at all. With completelyfree movement of goods but immobilityof factorsof production,and with all firmstransacting goods and servicesin a price-taking situation,thereis littleincentive forinternationaldirectinvestment (Kindleberger1969). But, withproduction by firmsoutside their national boundaries now thoughtto account for 15 per centof the world's output,theseare no longerreasonable assumptions. Standard theory, whether it be of the classical or neoclassical variety, makes no allowance for trade in factorinputs (Baldwin, 1970), largely because the conditionsnecessary to such trade are assumed not to exist. The most powerful attempts to incorporate capital movements into trade theoryin recentyears have come fromtwo directions. First,Mundell (1957), usingthe Hekkscher-Ohlin-Samuelsonmodel,assertedthe proposition that trade and capital movementsare substitutesforeach other and that the equalization of factor-priceratios implies the equalization of commodity price ratios. Second there has been the attempt to take account of changesin technologyor advances in knowledge,in the analysis (Johnson, 1968). In the static model, innovations are ignored altogether as production functions are assumed constant and identical (or nearly identical) throughoutthe world. Where they are introduced, e.g. in a comparative static situation, their benefits are assumed to be instantaneouslyand freely transferable.Such an assumptionis totallyunrealistic in a situationwhereinformation is costlyto produce,is enterprise specific, and is sold under conditionsof imperfect competition;wheregovernments both finance the output of new knowledge and impose barriers on its the patternsof dissemination, e.g. by the patent system,and, hence, affect trade and resourceallocation. These and othermarketconstraints both help fashionthe initiallocation of new productsand processes,and at the same time,induce the means by whichbarriers to the diffusion ofthe knowledgegivingriseto theseproducts and processes may be overcome. Beginningwith Posner (1961), a steady stream of writershave attempted to demonstratehow innovationsin one countrymay affect the comparative advantage of countries,and how the trade initiallygeneratedmightbe gradually eliminatedby the recognition and imitationofthe innovationselsewhere. Various modelshave soughtto explain the process of the transference of productionfromthe innovating country. Of these,the product cyclemodel (Hufbauer 1966; Vernon,1966; Stobaugh, 1968; Wells, 1972) has, perhaps, come nearest to explicitly recognizingthe role of MEs in this process, although in their writings, Hirsch (1967), Wilkinson(1968), Quinn (1970) also accept that it may play an important role. Other economists, e.g. Gruber, Mehta, and Vernon
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(1967) and Keesing (1966), have also observed the relationshipbetween and trade,and more investment international the productionofknowledge, of trade in recentlyBaldwin (1970) has called foran explicit incorporation factorinputs into trade theory. In explaining how and why international production arises, trade economistshave tended to emphasize,first, the conditionsunderwhichthe foreignmarkets of a particular country are best exploited through the of its firms affiliates producingin those marketsrather than by exports, and second,the possible consequencesofthison existingproductionoutlets and trade patterns. The productcycle theoryassertsthat initiallyproduction will be located in the countryof innovation,and sold there. Exports followas new marketsare sought,but in due course,dependingon relative exchangerates' and demand and supply conditionsin importing countries, indigenousproductionmay become profitable.Whetheror not this output offirms ofthe innovatingcountry willbe suppliedby local firms or affiliates to entryfacingthe two groupsoffirms, willdepend on the barriers and their It will also be influenced relativeefficiencies. by the strategyof enterprises towardstheir foreign operationsand thetypeofmarketstructures)in which they are competing. Of the barriers to entry facing indigenous firms, Hufbauer (1966) has stressedthe technologicalgap caused by the lag in the transfer in technology international whileVernon(1966) places rathermore emphasis on market constraints. Both writers,however, see the ME as forsurmounting these barriers. The finalphase of the cycle an instrument is wherethese producersmay themselvesbegin exporting,competingwith firms even in their domestic markets. the product-innovating oftrade (Hufbauer, Both approachesand otherneo-technological theories 1971) are micro-oriented and differfrom received theory in two major respects. First, they are more concerned with the behaviour of firms than of countries; second, as they have so far been presented, they are particular,ratherthan general models as they tend to endow innovating firmsand countrieswith special economic characteristicsand, in consequence, patternsof productionand trade. Vernonhimself accepts that the product cycle sequence is less satisfactoryin explaining the territorial of productionof MEs which adopt a global strategytowards distribution theiroperations(Vernon,1972), while thereis some doubt that the process adequately explains the sequence of events when innovations originate fromcountrieswith (relatively)low incomes and wage costs and/orsmall markets(Dunning, 1971). Nevertheless, the models are of especial interest
1 Where, forexample, the exchange rate of the exportingcountryis overvalued, outward investmentwill be favoured relative to exports; where the exchange rate of the importing country is overvalued, inward investment will be favoured relative to imports. Some commentatorshave argued that the rapid increase in the level of U.S. foreign investmentin the 1960s was due largely to reflectedthe overvaluation of the dollar.
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in that theyemphasizethe role ofinnovationsin forging new trade patterns within an imperfectly competitiveenvironment, conditionswhich are the seed-bed of growthof the modernME. The value of the trade approach to understanding'why international production?' is that it remindsus that foreign directinvestmentis one of market. Though the preciserelationvarious ways of exploitinga foreign ship between these alternativeshas yet to be analysed in the literature, various case studies ofthe productcycle (Wells, 1972a) give usefulglimpses at whichpoint one means will tend to replace another. It is, of course,here the overlap with the location theory approach is best seen; it is here, to incorporatemovetoo, where trade theory most needs restructuring ments in factorinputs, even if some of these movements are not strictly of resourcesbetween one part of an ME and trade, but the transference another. interestof trade theoristsin this area because of One foreseesfurther the growingimpact of the ME on the flowsof goods and services across national boundaries(Robertson,1971). This willforceattentionon explaining the behaviourofsuch companies. Until recently,there have been few data to test systematicallyany trade-type hypotheses. These are now startingto emerge-for example data recentlycollectedby the U.S. Tariff Commissiongive sales and exports (includingintra-group exports) of U.S. and classifiedboth by industry foreignaffiliates, country;although, compared with the quality and detail of trade statistics,the situation is still themosthelpfullinesofapproach seemlikely unsatisfactory.Conceptually, the implicationsof dynamic comparative advantage to be two-fold;first, (Bruno, 1970; Klein, 1973) and particularlythose which arise fromthe incorporationof human capital and productive knowledge into capital (Johnson,1968); second, an analysis ofthe way in whichtrade is influenced by the ways in which marketsare exploited (e.g. by investment, exports, licensing,etc.). The explanation of factor endowmentand its impact on trade may give some insightinto the geographicaland industrialcomposiinvestment. tionofinternational Althoughtheseare largelymacro-concepts, they should provide a useful insight into reasons behind these formsof internationaltransactions. forexploitingforeign So far,we have thoughtofthe ME as an instrument markets. The second aspect of trade theoryconcernsthe question of the distinctive character of the ME as an owner of resources in different countriescomparedwithnational (i.e. indigenous)firms.The implications of this will depend on the type of operationsand the strategiesadopted by the ME, but in principlethey raise two issues. First, there is likely to be more specialization and integrationwhen such advantages occur than if these operations were conducted by independent firms; second, all
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intra-group transactionsinvolve the settingof transfer prices, which will affect the terms of trade. The determination of such prices will depend on circumstanceswhich,again, may requiremodifications to the assumptions underlying trade theory. 4. Location theory Like trade theory,location theoryhas so far had little to contributeto an explanationofthe level or compositionofinternational production.This is because location theoryhas traditionallyconfinedits attention to the territorial allocation of resources,and trade of firms withinnational boundaries; and only Ohlin (1967) and, to a lesser extent, Giersch (1950) and Weber (1958) have attemptedto go beyond this point. Yet, removingthis geographical constraint,the theory of location would seem central to answeringthe question 'why internationalproduction?'. Assuming the goals ofenterprises are unaffected by the countriesin whichtheyproduce, there is no reason why a U.S. firm,in choosing between a New York or a Paris location forits new plant, will be influencedby different criteria. To be sure, additional factorswill affectthe choice of a foreignlocation, e.g. the possibilityof exchange fluctuationsand differences in corporate tax rates, the risk of expropriation,etc., but, conceptually, there is no in embracingthese in the basic analysis.1 difficulty Location theory is concerned with both supply and demand oriented variables influencingthe spatial distribution of production processes, researchand development,and administration unliketrade theory offirms; it is not concerned withthe divisionoflabour betweencountries. Assuming a certain size and distributionof markets,and that each firmis a profit maximizeroperatingin a price-taking situation,productionwill be located where costs are lowest (Greenhut,1952) This, in turn,will depend on the at which these are availability and cost of factor inputs, the efficiency transformed into outputs, and the costs of movement fromthe point of productionto that ofmarketing. Some of the special featuresofproducing outside national boundaries can be incorporatedinto this kind of model to deal and an optimal solution found. But others may be more difficult with,e.g. the possibilityof exchange rate adjustments or political actions, partly because they cannot easily be quantifiedand partlybecause of the inherentuncertaintyattached to them.
1 Location theory also links with the theory of the growth of the firm. Firms expand their either by selling more of the same product to existing markets, or by diversifying products, processes, or markets. The territorial spread of production across national of markets; but it may also be linked boundaries partlyarises froma similardiversification to the new opportunitiesfor spatial specialization arising fromthe diversifiedproduct or process (or even functional)structureof firms.
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In contrast to thisapproach,demandoriented theories assume production costs to be independent of location and assert that the distributionof marketsand the locationofcompetitors willgovernthe sitingofproduction units (Losch, 1954). The theoriesofspatial interdependence are essentially an extension of the principlesof monopolisticcompetitionand oligopoly. Each location guarantees an element of spatial monopoly, the extent of which will depend on the characterof the market,the locational strategy and efficiency of competitors and movementcosts. It will also be affected or not a firm is operatby the characterofproduction, forexample whether ing under economiesof scale, as this will influence both the extentto which firms tend to clusteror disperseand the numberof firms involved. It is now generallyaccepted that any comprehensive theoryof location must incorporateboth cost and marketfactors,and that in an imperfectly location will not necessarilybe competitivesituation,the maximumprofit the one wherecosts are minimized(Greenhut,1952). (An analogy is with output and price determinationof a firmproducing under conditionsof oligopolywhereit can affectits profits by the size ofthe marketit chooses to exploit as well as its cost conditions.) Again, evaluatingthesefactorsas theyaffect thelocation ofinternational production, the picture is more complex but not significantly changed. Looked at from the viewpointofsupplyingany given market,the question can be discussed in two parts. One is to explain the spatial distribution of production units irrespectiveof ownership; the other is to explain the ownershipof these units. Assume, for example, a certain size of market for a particularproduct in the U.K., and that there are two nationalities of firms-U.K. and U.S.-which could supply that market, then what determines(a) the extentto whichthe marketis supplied fromproduction unitslocated in theU.K. or theU.S., irrespective ofownership, and (b) given the location of production,whetherthe nationalityof ownershipof these units is U.K. or U.S. ? The answer to these questions,to my mind,provides one of the keys to theunique characterofthe ME and lies at the coreoftheindustrial structure approach to 'whyinternational production?'. For, rephrased,the question of asks 'why is a market of a particular countryserved by the affiliates firms foreign-owned producingin that countryratherthan by indigenous firms? Location theorytackles this question fromthe viewpoint of individual firms; like capital and trade theory,however,it takes as data the information on costs and market size and structure. And, as we have suggested, given this data, it can not only explain actual location patterns,but can also indicate optimal patterns, subject to the uncertaintiessurrounding particular markets and future events. From the supply side, an ME is
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faced withthe same type of cost decisions as a national enterprise;but its purchasing and marketingoptions may be wider, and the evaluation of foreigninvestment climates may be a complicated business (Stobaugh, 1969). From the demandside, one observes the structureof competition, The Vernonthesis and hence marketsserved,may be somewhatdifferent. argues that the production of many new products and processes, first to another by a variety of discovered in one country,is later transferred means, one of which is through affiliatesof the innovating firms. This assumes that the innovating firmsboth create new markets,and supply these marketsinitiallyfroma domestic and then froma foreignlocation and and, in so doing,they may induce a certainresponsefromotherfirms futurelocational decisions. which may influence create a marketstructure firms is necessary(Kindlebetweenleadingandfollowing Here a distinction are both dynamicconcepts. berger,1969), as the marketsize and structure firms will competitivesituation,all profit-maximizing In a price-taking aim to produce an output at which marginalcost equals price. To do this, they may require to produce in one or more locations, depending on the relationshipsbetween production costs as output increases and transport costs as distance increases. There are no leaders or followers. In an market,the firmcan influencethe character of its market,and imperfect hence its optimal location. As far as producingoverseas is concerned,the firmmay do so to gain an advantage over existingproducers,or forestall new competition,or to protect its market share even though the rate of returnon new investmentmay be very small. In otherwords,the choice between exports and foreignproductionwill not be taken on purely cost oflocal productionon will also be given to the effects criteria;consideration the marketstructurein which the investingfirmcompetes and its ability competitive situation. In stressingthis factor, to sell in an imperfectly location theoryis useful,though both the ability and desire of the ME to by the fact that it is an ME, gain a footholdin a marketmay be influenced and explainingthe implicationsofthis falls outside the scope ofthe theory. Empirical studieson locationrelevantto MEs have so farfallenintothree main groups. First, there are those which have sought to evaluate the investthe location of eitherforeign factorsaffecting importanceofspecific ment or productionof MEs. These include Balassa (1967), Horst (1972), Jud (1973), NICB (1961) (costs), Kreinin (1967b) (anti-trustlegislation in investing countries),Krause (1972) (economic integrationin host counclimate),Scaperlanda and Mauer (1969) tries),Stobaugh (1969) (investment and Schollhammer(1972) (size of markets), Caves and Reuber (1971) and Morley (1966) (market growth), McAleese (1972) and Falise and Lepas incentives),Vernon (1972) (threatof competitivefirms), (1970) (investment and in a paper published earlier this year (Dunning 1973a) I tried to
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examine some of the principlesunderlying Britain's entryinto the E.E. C. on the location of internationalfirmsin the enlarged Community. It is difficult to generalize fromthese studies; such econometricwork as has been done seems to point to the size and growthof market as the single most important demand variable influencing foreigninvestment(Parry and Ahlburg, 1973). The secondgroupofstudies have adopted a sectoralapproach and looked at factors influencingthe location of foreign enterprisesin particular countries, e.g. Stonehill (1965), Brash (1966) (Australia), Daniels (1972) (United States), Deane (1970) (New Zealand), Forsyth (1972) (Scotland), Safarian (1966) (Canada), Schreiber (1970) (Taiwan), or industries,e.g. Boranson (1970) (motorvehicles), Harman (1971) (computers),Hufbauer (1966)(synthetic materials),Stobaugh (1973)(petro-chemicals),Tilton (1973) (semi-conductors)and Wortzel (1973) (pharmaceuticals),though most of these,as we have seen,have tendedto be an extensionofthesurveyapproach. A thirdgroupof economistshas been interested in location of industryas a featureofinternational competitiveness (Hirsch,1967,1973; Clark,Wilson, and Bradley, 1969; Dunning, 1971,1973a) and, in so doing,have given some offirms. attentionto thewayinwhichlocationis influenced bytheownership Of the morerecentattemptsto incorporatethe activitiesofMEs into the general frameworkof location theory, those of Hymer (1970, 1972b), Murray (1973), and Vernon (1973) deserve special mention. Vernonargues that the determinants of locational strategyof MEs will vary accordingto the stage of the product cycle which they are in. In both the initialstage of innovative oligopoly and in the final stage of mature oligopoly,their behaviour accords most closely with the interdependencemodel. In the intermediaryphases where oligopoly exists with some degree of price competition, cost considerationsare likely to be more important. As, however, MEs tend to be concentratedin oligopolisticindustriesand are an importantinfluenceon the formof the product cycle, Vernon claims that location theoristsshould place rathermore stress on the interdependence model. A ratherdifferent approach is taken by Hymer and Murraywho perceive offirms withinindustry, there that, parallel to the increasingconcentration is a trend towards the increasingspatial hierarchyof economic activity. MEs are acceleratingthis trend: on the one hand routinemanufacturing or marketingactivities are being dispersed accordinglargelyto cost criteria (e.g. why do U.S. firmschoose to produce transistorradios and cameras in Taiwan (ratherthan, e.g., Mexico) forexportback to the U.S. ?); on the other,certain activities,e.g. top level administration, policy formulation, decision-takingand risk-hedgingoperations, and the specialized inputs which serve these, e.g. technical and financialinformation, management
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centralized. The spatial expertise, skilledlabour,etc., are beingincreasingly the agglomeraarisingfrom these trends,and particularly interdependence tion of the higherorderfunctionshas importantimplicationsboth forthe and of economic distribution ofincomeearnedby MEs (and theiraffiliates), power between nations. Standard location theory is generally concernedwith these issues but itselfto explainingthe location ofplants of single-product, tends to confine national firms.Moreover,withinits analysis,many ofthe unique qualities associated with the ME, e.g. its ability to shiftinputs, such as human acrossnational boundariesat low or zero and knowledge, capital information costs arenotbroughtout. Product acceptabilityis also assumed to be interdependent of the location of supply. Because, too, received theorytreats the distribution of resourcesas fixed,it cannot incorporatethe situation, can in which firms oftencommonto MEs in the resourcebased industries, themselves affectthis distribution,e.g. by their pricing policies and/or exploitationpolicies. This is particularlytrue of operationsof MEs in the less developed countries. For these reasons,location theorycan give only a partial answer to the question 'why internationalproduction?'.
5. Industrial organization and market structure

(a) Concepts and analysts
The approaches to 'whyinternational production?' so fardiscussedhave been concerned with identifyingand evaluating the variables which in the locationoftheirforeign investment firms influence and/orproductive producactivities. The type of answersto the question 'why international or growthare tion?' theytend to elicitare 'because the prospectsforprofits than goals, 'because foreign promising'or, focusingmore on determinants labour costs are lower' or 'because there are barriersto exports, etc.' or 'because only by so doing can we protect our competitiveposition'. The followingparagraphs attempt to get beyond these indicative variables, and instead of asking 'what causes firmsto produce abroad ?'-which, in of capital, location, general,can be answeredwithinthe existingframework or trade theory-to ask 'under what conditionswill particularmarketsbe producingin that market ratherthan by supplied by the foreignaffiliates or imports?'. indigenousfirms In answering this lattertype of question it seems to me a complementary approach, viz. that of industrialorganizationtheory,is needed. This not only recognizes that internationaldirect investmentinvolves the transacross mission of a package of capital, knowledge,and entrepreneurship national boundaries, but that the ownershipand controlof the organizing is domiciled in a different unit of this package, i.e. the foreignaffiliate,
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country (or countries). This immediatelysuggests distinctivenesson the part of these affiliates vis-a-vis indigenouscompanies. To simplify our analysis, assume thereare only two countries(A and B) in the world and that we wish to identify both the locationand ownership of firms manufacturing one particularproduct-say a drug. Assume, too, that thereare threeways the marketin each countrymay be supplied,viz. withproducby the productionofindigenousfirms, by importsfromfirms of these tion units in the othercountry,and by the productionof affiliates firms the extentto which located in the local market. What will determine CountryA's firms will supply CountryB's marketfromproductionunits B 's B orthe extentto whichCountry located and ownedbythemin Country firmswill supply Country A's market by plants located and owned in CountryA? The way in which the question is phrased suggests that there are two primary determinantsof the amount of internationalproduction. The firstis the extent of the market in each country and the second is the competitivenessof foreignaffiliates vis-a-visindigenous and non-resident firms.To simplify mattersstillfurther, suppose both the size ofthe market and the price of the drug are fixedand identical in both countries. We are left,then,withdecidinghow the marketis shared betweenthe threegroups of firms. Take, first, some extremesituations. Suppose transportcosts (or other barriersto trade) between CountryA and CountryB are such that it pays neithercountryto export to the other. This means that each marketwill be suppliedfrom local productionunits. How will the productionbe shared between indigenousfirms and the affiliates of foreign firms? If it is a question of costs,what will determinewhetherthese favourone group of firms or the other? Again, take an extreme case. Assume that the productionof the drug requires knowledge of a formula which is the sole propertyof firmsin A's A. In the absence oflicensing orsimilararrangements, Country Country firmswill supply the market in both Country A and Country B until indigenousproducersin CountryB are both willingand able to innovate and produce a substituteproduct. If they do not, then the market will continue to be supplied by CountryA's firms. In this particular example, internationalproduction (by Country A's firms in CountryB) arises because of two absolute barriers,(a) the export of goods from Country A to B, (b) the inability of indigenous firmsin CountryB to produce a competitiveproduct. Now examine the opposite extreme. Suppose transportcosts are zero and that thereare no barriersto productionfacingfirms in eithercountry. Since knowledge is freelyand instantaneously transferable,production
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functions will be the same in both countries. In this situation,input prices will determinerelative costs. Suppose these strongly favour CountryB. Then in a perfectly competitivesituation,it could well be that all production will be concentratedin CountryB and that CountryB's firmswill supply CountryA's market throughexports. Since productionis zero in CountryA, it is unlikelytherewill be any firmsin CountryA who would wish to invest in CountryB, because of the additional risks and costs of operatingin a different political and economic environment at a distance fromits decision-taking centre(Kindleberger,1969). It is stillpossible for firmsin CountryA to invest in CountryB's firms, but the investment would be a portfoliokind. In between these two extreme cases, there are a host of intermediary a combinationof the ease or difficulty situations,each of whichwill reflect of supplyinga particular market with a product (or group of products) fromalternativelocations, and the ease or difficulty with which firmsof different ownershipcan supply the product (or group ofproducts)fromthe same location. Most of the research on internationaldirect investmenthas been concerned with explaining the second characteristic in termsof monopolistic competitivetheory(i.e. firms of different nationalitybut producingin the same location). They are succinctlysummarizedby Kindleberger(1969), Caves (1971), and Gray (1972). Expressed in termsofnet advantages MEs or their affiliatespossess over indigenous firms,the formerare usually consideredunder fourheadings: (i) an easier or cheaper access to knowledgeand information; (ii) an easier or cheaper access to factorinputs; (iii) a better access to markets or to the saleable characteristics of products e.g. brand names; (iv) economies of scale and vertical integration. It will be observed, however,that some of these advantages may be enjoyed by all branch plants, irrespectiveof the nationalityof the investing firm,and are to do with the internal and/or external economies of size is part of (Coase, 1937; Penrose, 1958). Others arise because the affiliate is part of an intea foreigncompanyand a thirdgroup because the affiliate grated multinationalcomplex of operations. These advantages, according to the Gray Report on Foreign Direct in Canada, conferon the ME (or its affiliates)an element of Investment whichgives them an edge over theircompetitors(or potendistinctiveness tial competitors) in similar locations. Essentially, they are enterpriseand are a functionof between firms, specific,i.e. they are not transferable and their characterand ownership. The reportperceives that some firms
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countries tend to possess the type of qualities which spawn distinctive advantages more than others. These include firmsin research-intensive products, while countries industries and those producing differentiated with large markets,a competitiveenvironment,a rapid rate of technoetc.,also tendto be moredistinctive.Yet small countries logical innovation, may possess distinctiveadvantages in particularindustriesor spawn firms with distinctiveadvantages withinindustries,which explains why trade and investmentcan be multilateral. Other economistshave also probed into the unique characteristicsof MEs. Johnson(1968), forexample, has stressedthe importanceof the role knowledge; Caves (1971, 1973) adds to this played by enterprise-specific equally important may be the advantages of product differentiation; production multinationalism intermsofeconomiesexternalto theparticular which are research unit but internalto the ME, particularlyin industries and in firms whichare intensiveand affordgreatest scope forintegration, in theiroperations,includingthose arisingfrom integragloballyintegrated tion. H. Peter Gray (1972) elaborates on this point, and distinguishes between 'aggressive' and 'defensive' motives for investing abroad. The largelyby formerseek to increase the economic rent of the investingfirm the means just described,and/orby obtaining a higherrate of returnon capital than is available domestically. Defensive investmentsare those which are made to protect some level of profit(or growthrate) attained earlier (Gray, p. 77). These include investmentsundertakento preserve a foreign marketpreviouslyserved by exports,and to aquire a safe source of raw materials. Finally, some of the younger economists,e.g. Wolfe (1971), Horst (1972b, 1973), Parry (1973), Knickerbocker(1973), extending themselves the earlierwork of Edith Penrose (1958, 1968), are interesting the formit the growthof the multinationalfirm, in the factorsinfluencing both. takes, and the importance of market structurein influencing in which firms to the been less has exploit Rather attention way paid theirdistinctive advantages. Whereproductionremainsin the hands ofthe firm with the advantages, this comes back to a question oflocation theory; or to licenseforeign to sub-contract but, in some cases, it may be preferable maximize the economicrent scheme to in some other or to engage producers, on distinctiveness(Hymer, 1972b). Though the literature (Kolde et al., 1968) is fullof examples of the conditionsunderwhichlicensingis likelyto to directinvestmentas a means ofexploitingforeign markets, be preferred these into the to formalize little theory -there has been systematicattempt of marketing. (b) The Aliber thesis Before consideringsome empirical work on the industrial structure
316
THE DETERMINANTS
OF INTERNATIONAL
PRODUCTION
approach, I would like to referbrieflyto the currencyarea approach to international production, which is reflectedchieflyin the writings of Aliber (1970, 1972). I can deal with it briefly not because I do not thinkit important, but because I thinkit can be accommodatedinto the conceptual scheme ofthe industrialstructure approach: it is also ofdirectrelevanceto capital theory. Of all approaches,Aliberis the one whichrecognizessome of the specific aspects of foreign investmentwhich are absent fromdomesticinvestment. Of these, investmentin a different currency area is the most obvious. As I understandit, Aliber is not concernedwith explaininginvestmentin the same currency area, e.g. U.K. investmentin Australia, but only wherethe assets are in different currencies. Since the value of any one currency fluctuatesover timeit immediately followsthat in additionto the variables which influence the worthwhileness of an investment in the local currency, its value in relation to other currencieshas to be considered. A rate of returnof 10 per cent with a currencythat devalues by 5 per centis worth 5 per cent less the depreciated value of the assets in other currencies. When they invest, firms will then capitalize their income streams taking account ofthese uncertainties. They will also affect the worthwhileness of trade relative to investment (though observe that a devaluing currency will also affectthe worthwhileness of trade as well); but fundamentally, therelationship withtheircompetitors.In otherwords,theAliberapproach adds to the theoryof industrial organization,but I do not think it supplants it.' Surveys have revealed that the value and expected variability of the exchange rate are taken account of by firms in deciding the location of their investment;neitheris there any doubt that short-term movements of resources are stronglyinfluencedby monetaryconsiderations. International companies have been seen to be both at an advantage and a disadvantage in this respect (Manser, 1973) (c) Recentempiricalwork As yet therehave been few attempts to test systematicallythe type of hypothesiswhichthe above approach suggests. There has been a good deal of descriptive analysis and casual empiricism,mainly contained in case and some hintsfromrelated studies on studies of countriesand industries, Mehta, and Vernon,1967; Mansfield, 1973). Primarily, technology(Gruber, but also the subject has the lack of progressis due to data deficiencies, and generallylacked appeal to economistsinterestedin market structure
1 Important to these discussions is thenumerairein which the ME keeps its accounts. Moreover,one needs to distinguishbetween the change in parities due to shiftsin the terms rates of inflation. of trade needed for balanced payments, and those due to differential I am indebted to H. Peter Gray forremindingme of this distinction.
J. H. DUNNING
317
location theory. However, recent contributionsby Parry (1973) on the determinantsof foreign investmentin Australian industry,and by Horst (1972a) in which he produces a model to explain the ways in which U.S. firmsexploit their Canadian and European markets-viz. by exports or direct investment-provide usefulstarting-points. Perhaps the most rewardingattemptto pinpointthe special characteristics of MEs has been that of James Vaupel (1971) in an examinationofthe 491 largestU.S. companies.' Vaupel classifiesthese companies into three groups,viz. national enterprises (NEs)-i.e. those whichmanufacture only in the U.S.; transnational enterprises (TNEs)-i.e. thosewhichmanufacture in at least one foreigncountrybut in fewerthan six; and multinational enterprises(MEs)-i.e. those which manufacturein at least six foreign countries. For the year 1964,therewere 125 NEs, 194 TNEs, and 172 MEs. He found that MEs had certain distinctivecharacteristics;for example, they funded2'4 per cent of theirsales on researchand development(compared with 1 6 per cent for TNEs and 0-6 per cent forNEs); they spent 2-5 per cent on advertising(compared with 1-9per cent forTNEs and 1-7 forNEs); they earned net profits of 89 per cent on investedcapital forthe period 1960/4(compared with 7-3 per cent for TNEs and 6-7 per cent for NEs); theiraverage sales were $460m. (compared with $200m. forTNEs ;2 and $160m. forNEs); theyweremorediversified in theirproductstructure theyrecordeda higherexports/sales ratio (6.4 per cent,cf.5-5per cent) and they paid higherannual wages in the U.S. ($6,841, cf. $6,774). From the angle ofrecipientcountries, a numberofstudieshave examined the comparative behaviour of foreignaffiliates and indigenous domestic firmsin Denmark, Holland, and Israel and found that the formerwere larger, more capital- and skill-intensiveand exported a higher proportion of theirtotal output. By contrast,Cohen's study of foreign and local firmsin South Korea, Taiwan, and Singapore (Cohen, 1973) showed that while the foreignaffiliates exported more, they also importedmore, and had a lower net output per head. Other studies of foreignaffiliatesin developingcountries reveal thereis no clear patternto theircapital/labour ratios (vi8-a-vi8 indigenous firms) (Strassman, 1968; Pack, 1972; and Wells, 1972b) or to theirrecord as wage payers (Katz, 1972). In our own most recent research on U.S. investmentin the U.K. (Dunning, 1973b), of the 500, we attemptedto analyse and explain the industrialdistribution affiliates.Tables II and III presentdetails of largest U.S. manufacturing in fortysectors of U.K. industry the distribution of sales of U.S. affiliates and certainsupplyand marketing in 1970/1, theirconcentration coefficients,
As listed by Fortune. The measure chosen here was the number of 2, 3, and 5 digit industriesin which they operated: the results were MEs 5, 10, and 22; TNEs 4, 7, and 15; and NEs 2, 3, and 8.
2
318
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THE DETERMINANTS
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characteristics of the industriesin question. The concentrationcoefficient is derivedby calculatingthe percentageof sales ofall U.S. affiliates accounted for by a particularindustrydivided by the percentage of sales of all U.K. firms accounted forby that industry. A concentrationcoefficient of morethan one shows that U.S. affiliates are rather more concentratedin that industrythan forall industry;a concentration coefficient of less than one suggeststhe reverse: The fivesupply featuresexamined in Table II are: 1. total net capital expenditureper employee (an average of 1963 and 1970 figures), as an index of the use made of non-humancapital, i.e. plant and equipment, etc.; 2. the proportionof non-operativeto all workersin 1970 as an index of the use made of human skills; 3. the value of research and developmentexpenditure(annual average 1967/9as a percentage of sales (1968) as an index of technological intensity; 4. the labour productivity of the largest 10 per cent of establishments of 1963 divided by the labour productivityof the other 90 per cent as an index of the extentto which large firms enjoy economiesof scale; 5. the proportionof advertisingcosts to total sales in 1963 as an index of product differentiation. The three marketingfeaturesexamined in Table III are: 1. the growthof output between 1958 and 1970 divided by the growth in GNP as an index of the expenditureelasticityof demand; 2. the export/import ratio in 1967 as an index ofthe comparativetrading advantage of the U.K.; and 3. the output of the fivelargest firms in an industryas a proportionof the total output of that industryin 1963, which illustratesthe type of market structurein which U.S. affiliates operate. Tables IV and V summarizethe data contained in these tables. Table IV with that of U.K. compares the industrial distributionof U.S. affiliates firmsas a whole. The value of each characteristic presentedin Tables II and III is weightedby the distributionof, first, and second, U.K. firms, and then averaged to give the figureset out in Table IV. U.S. affiliates, tend to The conclusionsof this exercise are self-evident.U.S. affiliates and export-oriented be more concentratedin faster-growing industries. advanced industries,and to They are also attracted to the technologically those where both capital and advertising expenditure is slightlyabove average: these are also the industriesin which the barriersto entryfacing indigenous firmsare likely to be higherthan those facingU.S. affiliates. no evidenceto suggestthat theirshareofindustries which Thereis, however,
J. H. DUNNING TABLE IV
323
Summaryofcharacteristics ofall U.K. firmsand U.S. affiliates

Average figures U.K. firms Supply characteristics 1. Net capital expenditure per employee 2. Non operatives/total workers 3. R and D expenditureas a % of sales 4. Economies of scale 5. Advertising expenditureas a % of sales Marketingcharacteristics 1. Output growth/GNP growth 2. Exports/Imports ratio
3. Concentration ratio
U.S. affiliates ?221 21 30-3% 1-601

1.092
?191.0 26.2% 1-08

1.092
1-18
1-33'
1.022
1.232
70.92
1.142
74.72
1.662
1 Values of characteristics fromTable II weightedby distribution of U.S. sales/ employment. 2 Values of characteristics fromTables II and III weightedby distribution of U.K. and U.S. sales respectively.
SouRCE:
Tables II and III.
TABLE V
characteristics ofsupplyand marketing of U.S. affiliates by Classification concentration coefficient

Supply characteristics1 1 ? Group 1 (10 industries) coefficient U.S. sales concentration 7-50to 2-90 Group 2 (11 industries) 2-64to 1-13 coefficient U.S. sales concentration Group 3 (9 industries) coefficient 0.88 to 0-33 U.S. sales concentration Group 4 (9 industries) coefficient U.S. sales concentration 0-32to 0-02 2 % 3 % 4 5
characteristics2
Marketing 2 3
440 9 37-5 270-0 32-7 294-4 28-6 157-1 27-2
2.753
1-094 2-42r 1-354 2-307 54-414 1-05 4-274 1-284 1-904 71-81 1-04 1-075 1-066 0-977 63-30 1-12 0-96 0 954 1-80 61-37
0-714
For definitions of marketing see Table III. characteristics 11 industries only. 8 industries only. 5 industries only. 6 industries only. 7 7 industries only. SoURCE: Tables II and III.
2
1 For definitions of supplycharacteristics see Table II.
benefitfromthe economiesof scale is greaterthan that ofU.K. companies, and their market structureis only slightlymore oligopolistic. Table V classifiesthese same characteristicsby four groups of U.S. affiliates.Group 1 consistsof the ten affiliates withthe highest concentration ratios (from7 50 to 2.90); Group 2 ofthe eleven affiliates withthe next ratios (from2-38 to 1.19); and Groups 3 and 4 of the highestconcentration
324
THE DETERMINANTS
OF INTERNATIONAL
PRODUCTION
eighteen firmswith concentrationratios of below 1. The results of this the general pattern already stated. exercise confirm What, next, of an explanation forthe structureof U.S. participationin U.K. industry? Two propositionsmightbe tested. First, that U.S. firms will produce most in the U.K. in those industrieswhere both the growth and/orprofitpotential is favourable relative to that of exploitingforeign markets by other means, e.g. exports. The second is that U.S. firmswill invest in those industrieswhere the comparative advantage of the U.S. is greatest vis-a-visthat of U.K. firms. firms While data limitationspreclude any systematictesting of these hypotheses, certainpointersmay be obtained by looking again at some of the statisticscontainedin Tables I, II, and III and also some additional figures set out in Table V. in the U.K. Index (1), forexample, expresses the sales of U.S. affiliates as a ratio of U.K. importsfromthe U.S. This shows very clearlythat this is ratio is highestin those sectorswherethe U.S. concentrationcoefficient on the the highest. Index (2) presents details of the U.K. nominal tariff imports of various goods; there appears to be no obvious relationship and eitherthe U.S. concentrationcoefficient between the size of the tariff or the previousindex. (An exerciseby Horst (1972) whichused estimatesof rates ofprotectioncame to broadlysimilarconclusions.) Index (3) effective ofU.S. affiliates and suggeststhat the gives details ofthe total productivity do tend to concentratewhere this is highest,and the remaining affiliates threeindices (4) to (6) presentdata which are intendedto be surrogatesfor barriersto entryinto particular industries. Here, the propositionis that these are likelyto be the greatestin those industrieswherethe contentof or wherethe costs of entryare high,or productiveknowledgeis important, is most marked. The data in Table IV where product differentiation to this hypowhich summarize our conclusions,lend some corroboration thesis. The data analysed hints of some raison d'9treto the structureof U.S. participation in U.K. industry,but it does little more than this. There are various reasons for this but perhaps the main ones are (i) that the industrial classificationis not fineenough for us to be able to say much about the relationship between investment and exports as a means of exploiting a market, (ii) other locational variables, noticeably transport and labour costs, are ignored,and (iii) sales are not always a good guide to the value added by the firms. and The first acute wherefirms are multi-product problemis particularly i nvestmentand exports may complementas well as substitute for each other. This suggeststhat internationalproductiongives awareness to the products only produced by the investingcompany in local markets; more-
J. H. DUNNING
325
be required. The evidenceon therelationmight over,parts and components at a macrolevel is inconclusive investment ship betweenexportsand foreign (Hufbauer and Adler, 1968; Reddaway, 1968), however much at a micro level clearly they may substituteforeach other. Such relationshipsbecome rathermore complex when the activities of integrated. Taking the latterpoint and regionally MEs become industrially a companymay replace exportsto halfa dozen European countriesby first, setting up a plant in one of these and supplyingthe entire market from there. In this case, the productionimplicationsforthe countryin which the plant is located will be much greaterthan the replacementof imports might suggest, while, in other countries,European imports will replace U.S. imports. this will take the patternmentionedearlier As to industrialintegration, of horizontalor verticalspecialization of products or processes. In our owned by CountryA manufacturedtwo drugs earlier example, ifthe firm it might decide to concentratethe production of one in CountryA and supply both countriesfromthat plant, and concentratethe productionof the other in CountryB and supply both markets fromthere. Or it may productionin a plant in CountryA, export the semiengage in first-stage processed good to CountryB, have it made up there and then sold in both countries. In this case there is intra-grouptrading as well as two-way producof international investment. Seeking to explain the determinants complex,although basically it is an exercise tion then becomes extremely (Penrose, 1958; Horst, 1973), and, as in the theoryof the growthof the firm of a foreignfirmmay possess net an affiliate fact that we have said, the advantage over local producers may lie in the nature of branch plant integration. An indigenous competitive economies,and enterprise-specific forexample, mighthave to engage in settingup costs already incurred firm, elsewhere in the firm'sorganization. The desire to achieve the economiesof industrialor regionalintegration to is, of course, less an explanation of the initial decision of an enterprise that an established company set up a foreign productionunit as a strategy parts might pursue. Many American firmsalready operatingin different of Western Europe are now rationalizingtheirproductionprogrammesin and such a way as we are likelyto have importantlocational repercussions, trade between the will almost certainlyincreasethe volume of intra-group individual European affiliates.But again,here,no new principlesofgrowth are involved. research (d) Lines forfurther One conclusion which followsfromthe previous paragraphs is that the than 'why production?' is now less interesting question 'why international
326
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THE DETERMINANTS
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the presentrate of growthin internationalproduction?' or 'why the particulargeographicalor industrialpatternof international ?' and production that futureresearch should be focused on the dynamics of multinational enterprises and comparativestudies. On thefirst point,various explanations mightbe adduced both oftheincreasing roleofsuch institutions in theworld TABLE VII ofcomparative advantagecharacteristics of U.S. affiliates Clacssiftcation bysales concentration coefficient
1 Group 1 (10 industries) U.S. concentration coefficient 7-5to 2-90 28 51 Group 2 (11 industries) U.S. concentration coefficient Group3 (9 industries) U.S. concentration coefficient 6.33 0.88 to 033 Group 4 (9 industries)
U.S. concentration coefficient 2-64 to 1413
19.32
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19-35 1.435
16-9 17.03 1.49
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Table VI.
economy and their changingcharacter. One of these is simply that they tend to be concentrated in the new industries whichare growing fasterthan the average in the worldeconomy. The second is that MEs seem to be more profitableand grow faster than indigenous firms(Dunning and Pearce, 1971) which enables them to acquire the necessaryresourcesforadditional growth. The third is that as the firmsincrease in size and become more established,the chances of competitorsbreakinginto the market are less. The fourth is that as theygrow,the companiesoftenenhancetheircompetitive advantages, sometimesby tightening up on controlof market,sometimes increasingintegrationand so on. All ofthese are symptomatic ofbroad trendsin industrialstructure.One oftheseis the generalincrease in industrialconcentration withinparticular countriesalthoughnot forthe world as a whole. The proportionof motor cars, petrol, rubber tyres, pharmaceuticals, etc., produced by (say)
J. H. DUNNING
329
the five largestcompanies in the world has fallen in recentyears-largely due to the resurgencein Japanese and European competition(Rowthorn, 1969). There is nothing inevitable about this trend of growth of MEs. Anything which reduces the barriers to competition on which these companies thrive may reduce their share of output. The end of a patent could mean that a foreignaffiliate is no longerprotectedfromindigenousfirms, and loses its competitive edge; thishas happend in the U.K. pharmaceutical industry (Cooper and Culyer, 1973). Or a new product mightreplace an old one whichcan be moreeasily producedby competitive companies; the decline of the share of U.S. affiliates in the foundationgarment industry is an illustration here. There is a substantial learning process associated with competition engendered by international companies; the declining share of the main U.S. affiliatein the razor blade industryis a case in point; though,as oftenas not, competitioncomes from other internationalcompanies. The second line of research which needs pursuingis a more systematic analysis of the distinctivenessof MEs and alternative formsof market penetration, by country and industry.'Why is it,forexample,that although the U.K. and U.S. account for 35 per cent of world exports they are responsiblefor70 per cent of the world's investment incomein 1968? Why is the broad industrialpattern of the Japanese MEs different fromthat of theirU.S. and European counterparts? (United Nations, 1971). Why do the sales of foreignaffiliates/export ratios of countriesdiffer enormously, being, forexample, high forthe U.S., Switzerland,Sweden, and Holland and low in Japan, France, and Italy?; and of industrieswithincountries, and cotton e.g. cf.motorvehiclesand computers withindustrial instruments textiles? Various possible explanations come to mind. One is to do with the structure of a country'scomparativeadvantage. Wherethisis in goods which can be easily tradable or can be easily assimilatedabroad the percentage might be less. Another may have to do with structureof markets; dispersed marketsmay make foreign productionuneconomicalwhile more concentratedmarketswould not do so. A thirdis to do with the different organizational patterns of MEs of different nationality (Stopford, 1973; withthe attitudesand policiesofboth exporting Franko, 1972); and a fourth countries to exports relative to outward investment, and importing countriesto importsrelative to inward investment. This, in turn,will be related to balance of payments questions. If the dollar is in short supply but the yen is plentiful, then under a fixedexchange rate, tariffs mightbe while placed on dollar goods whichmightencourage defensiveinvestment,
1 The work now being undertakenby Raymond Vernon and his colleagues on European and Japanese MEs should prove particularlyilluminatingin this respect. See also Hellman (1970).
330
THE DETERMINANTS
OF INTERNATIONAL
PRODUCTION
capital outflows Japanese firmscan export freely. Methods of restricting also vary between countries(Cairncross,1973). A fourthreason concernseconomic conditionsin investingor exporting countries. Firmsdo notusuallylookoverseasformarketsifones nearerhome production. can be satisfied. And generallythey prefer exports to foreign The moreprofitable the opportunities forgrowthat home, the less foreign markets will be vigorouslypursued. I believe the lack of German and Japanese foreign investmentfora long time since the Second World War can be largelyexplained in terms of the rapid internalgrowthof the two favoured economies,and the factthat theundervaluationoftheircurrencies the exploitation of foreignmarkets by exports rather than by outward directinvestment.Now theseconditionsno longerhold, thereare signsthat both countriesare becomingimportantforeign investors. But the extentto face demand pressuresin domestic or foreignmarkets which which firms theirlevels offoreign can be met withoutproductionoverseas willinfluence activities. Lastly, government policy is vitally important. This may be exerted in various ways, both by direct controls (Herring and Willett, 1972) and affectingthe value of the variables which influencedecision-takingby to invest overseas. This is very relevant to the question 'how much firms international production?' but can also influence 'why international affecting production?'. There are many obvious examples of government the behaviour of internationalcompanies and it seems likelythat the role will become even more importantin the future.
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The Determinants of International Production Author(s): John H. Dunning Source: Oxford Economic Papers, New Series, Vol.

OF INTERNATIONAL DETERMINANTS PRODUCTION'

The issues involved

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Tables II and III.

characteristics ofsupplyand marketing of U.S. affiliates by Classification concentration coefficient

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in Britain,an E.A.G. Business Research Study,Financial UnitedStatesIndustry

and PEARCE, R. D., 'The world's largest companies: a statistical profile',

AmericanEconomicReview,vol. 59, 1969.

of Commerce, 1973. and technologicalchange' in J. H. MANSFIELD, E., 'The multinationalenterprise

Review, vol. 47, 1957.

Investmentand Business, No. 2, 1973.

AmericanEconomicReview,vol. 59, 1969.

and MAIJER,L. J., 'The determinants of US direct investment in the EEC',

Diffusionof Technology:the Case of Semiconductors, J. E., International The BrookingsInstitution,1973.

Studies,vol. 26, 1958.

J. W., Characteristics and Motivations of the US

in a Low Wage Economic Man and EngineeringMan: Choice of Technology

Patterns, Private Planning Association of Canada, Montreal, 1968.

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