Please read the ‘Critical Thinking and Discussion Questions’ on page 269 and answer the questions No.2 and 3.
No2. Compare and contrast these explanations of FDI: internalization theory, Vernon’s product life-cycle theory, and Knickerbocker’s theory of FDI. Which theory do you think offers the best explanations of the historical pattern of FDI? Why?
Although Knickerbocker’s theory and its extensions can help to explain imitative FDI behavior by firms in oligopolistic industries, it does not explain why the first firm in an oligopoly decides to undertake FDI rather than to export or license. Internalization theory addresses this phenomenon. The imitative theory also does not address the issue of whether FDI is more efficient than exporting or licensing for expanding abroad. Internalization theory addresses the efficiency issue. For these reasons, many economists favor internalization theory as an explanation for FDI, although most would agree that the imitative explanation tells an important part of the story.
Vernon’s theory has merit. Firms do invest in a foreign country when demand in that country will support local production, and they do invest in low-cost locations(e.g, developing countries) when cost pressures become intense. However, Vernon’s theory fails to explain why it is profitable for a firm to undertake FDI at such times, rather than continuing to export from its home base or licensing a foreign firm to produce its product. Just because demand in a foreign country is large enough to support local production, it does not necessarily follow that local production is the most profitable option. It may still be more profitable to produce at home and export to that country. Alternatively, it may be more profitable for the firm to license a foreign company to produce its product for sale in that country. The product life-cycle theory ignores these options and, instead, simply argues that once a foreign market is large enough to support local...
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