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Foreign Direct Investment (FDI) theories: An overview of the main FDI theories

  1. Abstract.
  2. Defining Foreign Direct Investment.
  3. FDI theories on a macroeconomic level.
    1. Product Life-Cycle Theory (Vernon, 1966).
    2. Oligopolistic Reaction Theory (Knickerbocker, 1973).
  4. FDI Theories on a microeconomic level.
    1. Business Behavior Theory (Baumol, 1959).
  5. Eclectic Paradigm - The OLI Approach (Dunning, 1993).
    1. Ownership advantages.
    2. Location-specific advantages.
    3. Internalization advantages.
    4. Economic Integration and FDI.
  6. Conclusion.

Foreign Direct Investment (FDI) acquired an important role in the international economy after the Second World War. The increase of the volume of foreign direct investment was so sharp that economists considered FDI as a new stage of Capitalism after the classic Marxist theories of Imperialism. The country with the highest volume of FDI outflows after the Second World War until the 1980s were the United States, which undermined the role of Great Britain, the “traditional” country of FDI during the pre-war period. With the exception of these two countries and Japan, which had established legal restrictions in relation to FDI inflows, other important countries of FDI outflows were Germany, Holland, France and Canada until the mid-1970s.

Tags: Advantages of Foreign direct investment, Risks of Foreign direct investment, Benefits of FDI, FDI foreign direct investment, Foreign direct investment statistics

[...] MNEs should primarily possess certain ownership advantages in order to support their decision to invest in a foreign market and to exploit their competitive advantages within the context of monopolistic force that these advantages provide. Location-specific advantages: Each country has its own factors of production, level and quality of consumers, legislation, climate, etc, which may encourage or discourage a MNE to invest in a particular foreign market. Location-specific advantages theory encompasses the advantages that arise from using resource endowments or assets tied to a particular foreign location and that a firm finds valuable to combine with its own unique assets such as technological, marketing and/or management know- how. [...]


[...] Product Life-Cycle Theory fails to explain why it is profitable for a firm to undertake FDI instead of continuing export from home or licensing a foreign firm to produce its products. It simply argues that once a foreign market is large enough to support local production, FDI will occur. Hence, it fails to identify when it is profitable to invest abroad. Advocated of Vernon’s theory assert that beyond the differences in the production costs, there are also other factors that make international trade disadvantageous, such as various forms of governmental interventionism, but also the aspiration of the U.S. [...]


[...] FDI Theories on a microeconomic level Business Behavior Theory (Baumol, 1959) MNEs are also interpreted based on the complex environment of incomplete markets, which is the result of governmental interventionism and the competitive advantages that certain firms have against others. As incomplete markets render the maximization of corporate profitability very difficult, a conflict evolves between the shareholders and the managers of the firm. This segregation reflects the different interests that these two groups possibly have. Shareholders seek for higher profits through higher dividends, while managers seek for higher sales aiming to achieve personal objectives as well. [...]

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