Eclectic Paradigm

Now that we have established how the locational scope of an industry is relative to the nature of its output. This essay moves on to identify under which conditions we see firms operating within a domestic industry shift production overseas regardless of the tradability of output. To explain this, we now move on to Dunning’s eclectic paradigm. This theory offers a framework through which it is possible to identify and evaluate the significance of factors influencing both the initial act of overseas operations by firms and the growth of such operations. Dunning discusses that in order for firms of one nationality to successfully compete against firms in a different nation, they must possess certain competitive or monopolistic advantages specific to their natural ownership. These advantages must be sufficient enough to compensate the costs of setting up and operating a foreign tax deductible operation, in addition to cost of competing against indigenous firms. Ultimately, the theory explains that the extent and pattern of international production can be assessed by a set of three factors:

Ownership-specific advantages

The first condition for international business is that there must exist an ownership-specific advantage in order for a firm to leverage the cost of overseas operations. Economist Stephen Hymer has stated in the past that “outbound activities could occur only if the firm possesses a particular advantage over the local firms to compensate for the lack of the understanding of the local market environment.” (Rugman et al., 1985) These particular advantages may be derived in three ways: a) through the exclusive possession or access to income generating assets b) through the advantage of common governance – the economies of scale and scope c) through technological knowledge involving any form of innovation. Should a firm have a monopoly over its ownership-specific advantages, this would result in a higher marginal return or lower marginal cost