The Theory of the Transnational Corporation at 50+
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The paper briefly summarizes the historical evolution of TNCs and their activities. It then introduced the major theories developed to explain the TNC. There is an attempt to place the theories historically, within the context of the socio-economic conditions and of the relevant economic ideas in which they were developed. The following theories are discussed. Hymer, market power and control; Vernon’s international product life cycle; the internalization theory; Dunning’s eclectic framework based on: Ownership, Location, and Internalization (OLI) advantages; The Scandinavian School; the evolutionary approaches of Cantwell and of Kogut and Zander; the New Trade theory applied to the TNC; the role of nation-states in the strategic behaviour of TNCs. There are some critical comments at the end of each presentation. A brief analysis of key elements in the theories, their differences and commonalities follows in. It is pointed out that the pattern of development shows tensions between the following interconnected elements: (1) Contents and methods of interest to Business Schools and to Economics Departments; (2) Static versus dynamic approaches; (3) Emphasis on efficiency versus strategic elements; (4) strategies towards rivals as well as towards other players in the economic system such as labour, governments and suppliers; (5) and single- versus multi-disciplinary approaches.
This paper offers a splendid overview and a succinct summary of the theory of international business. It should be especially helpful for Ph.D. students in this field, and perhaps for other scholars that are coming into the area from other specialisms, or considering doing so. The article extends the author’s recently revamped book, Transnational Corporations and International Production: Trends, Theories, Effects (Ietto-Gillies, 2012), which book I commend and indeed which I use myself as a central text on my own doctoral course in the Theory of International Business. The author knows already of my views on many of the issues she discusses, both because she refers to some of my earlier work in the paper, and from some direct correspondence that we had in the past over her book, when she was writing it or re-writing it.
Ietto-Gillies is right to recognize that the issues addressed by the theory have altered over the 50+ years as the environment has changed, and with it so has the nature of the subject; and by the migration of the subject from departments of economics, and to a slightly lesser degree from departments of marketing and of finance, to becoming incorporated in its own right in business schools, most often within departments of management and sometimes in standalone departments of international business. I detect in the paper some sense of disappointment on the part of the author that the subject areas of economics and international business have diverged over the period described. As Ietto-Gillies has described, the theory of international business was spawned from economics a little over 50 years ago. The subsequent narrowing of the discipline of economics that has moved it away from the domain of international business studies will be well known to WEA members. The philosophically deep, historically rich and complex thinking of scholars such as John Dunning or Dick Nelson, impoverished if overly formalized, which was so welcomed in the economics profession of the 1960s (or in any earlier era) would not be so welcome today. Nelson has termed what has been lost or relegated to a secondary place within the economics discipline as ‘appreciative theory’ (see e.g. Nelson, 1998). Appreciative theory is closer to the complexity of real world social and economic systems, and to their changing historical context than is the deductive logic, axioms and more restrictive assumptions of formal theory. Evolutionary economics in the tradition of Nelson and Winter, in common with international business studies has instead returned to the traditions of classical political economy in relying on appreciative theory as the primary driver of analysis that explains real world processes, and which in modern terminology we would call multidisciplinary and interdisciplinary in nature.
International business as a subject area has moved steadily further down this road of multidisciplinary theory building grounded on empirical observation, despite adopting some quantitative methods that simplify relationships and which come with a language taken from certain natural science contexts (hypothesis testing and controls) that is questionable when applied to complex social systems in which we cannot conduct controlled experiments. However, since formal representations of international business theory tend to be associated with quantitative applications they are also designed to have a direct connection with some aspect of empirically observed phenomena (rather than model building for its own sake not directly linked to any observation, as in much neoclassical economic theory), and the purpose of this formal structure of tests against the evidence is generally seen as a capacity to draw conclusions that have conceptual implications which feed into the enrichment of and the new contribution to some relevant appreciative theory. As Nelson argues, when a subject is progressing well, there is a largely positive and constructive relationship between appreciative theory and formal theory, or formal representations of relationships. Given this relative openness of the international business subject area it is not surprising that inputs have been accommodated or absorbed from beyond economics, and especially from those working on the sociology and psychology of management.
Ietto-Gillies does a good job of showing how the theory of international business has evolved in terms of the analysis of its dominant actor, the transnational corporation (TNC), and in evaluating the strengths and weaknesses of the various components of that theory that have emerged along the way. I would add the interpretative comment that the theory has become steadily more multi-level as it has moved from macro level appraisals to incorporate more micro elements. This of course is related to the points I have made already, about the move from economics and finance towards management and strategy, and interest in more micro and individual aspects of the subject from scholars with backgrounds in sociology or psychology. While Hymer and Dunning began by analyzing patterns of FDI at the country and industry level, and Vernon explained cross-country patterns of trade and FDI, those such as Buckley and Casson or Johanson and Vahlne shifted attention to the firm level, and the more recent scholarship of those like Birkinshaw has brought this down to the firm sub-unit or subsidiary level. More recently still work has begun at the project level, which is appropriate where intra-firm networks become increasingly interconnected with inter-organizational networks, as hinted at in Ietto-Gillies’s reference to the trend away from internalization and towards externalization (outsourcing, subcontracting and the like). Our theories of international business need increasingly to be adapted to handle a synthesis of these various levels. While it is quite common to discuss multi-level analysis simply in terms of the required statistical methodology, the point I would emphasize here is that it calls for theory which is complex and multi-disciplinary in nature. Therefore, it is unsurprising that the trends in the international business field towards the explicit incorporation of different levels of analysis on the one hand, and towards more multidisciplinary and interdisciplinary approaches on the other, have gone hand in hand with one another.
The recognition of a change in the international business environment from internalization towards externalization leads me to two other comments on Ietto-Gillies’s article. First, Ietto-Gillies is right to draw attention to the conflation of ownership and control in the literature on international business from Hymer onwards. As conveniently also reflected in the definition of FDI used by the agencies responsible, an ownership stake in a business abroad above some threshold share of equity is supposed to be both necessary and sufficient to ensure control over the management of that (thus) subsidiary company. In the earlier era of internalization it seemed quite appropriate to associate the ownership of assets with the capacity to control the use of those assets. Of course, it was always understood that sometimes such control might not be actively exercised despite the existence of a majority holding, or equally sometimes control might be exercised over enterprises such as dependent suppliers despite a lack of ownership in their business, but these were often regarded as minor qualifications – the exceptions that merely proved the rule. Today, however, we must acknowledge that firms often exercise control over much wider international business networks in forms that are commonly known as global production networks or global value chains, in which substantial parts of the network or chain are not owned, but are effectively controlled or orchestrated by the flagship firm. This led Dunning, for example, in his later work to shift away from the traditional definition of the TNC in terms of the ownership of income-generating assets abroad, and towards defining the TNC instead as a firm that takes the lead responsibility for the orchestration of international business networks (see e.g. Dunning and Lundan, 2008).
As an aside, the new trade theories discussed by Ietto-Gillies are less able to explain the spread of global production networks than are the new firm level approaches to international trade that have emerged from more empirically oriented economists working on trade and TNCs (e.g. Feinberg and Keane, 2006). In this perspective, which is echoed in recent work in international economic geography (see Iammarino and McCann, 2013), the expansion of both international trade and TNCs is to be explained not be a change in transport costs or trade barriers (so long as these continue to remain relatively low by historical standards) but by a change in inventory holding costs made possible through ICT-based innovation and the associated organizational innovations, most notably the just-in-time system. While the econometric demonstrations of this have been in terms of intra-firm or intra-TNC trade (using the traditional definition of a firm in ownership terms), and this is still largely necessary for measurement reasons, the underlying explanation applies just as readily to the emergence and growth of global value chains that incorporate various partner or affiliated organizations into the wider international networks of the TNC. All this of course reinforces the point that Ietto-Gillies has rightly stressed from my own work, namely that trade, FDI and contractual partnerships are largely complementary in processes of TNC growth, and indeed they have become ever more so in recent times.
A second observation here is that I doubt whether internalization theorists would accept Ietto-Gillies’s claim that they are at a loss to explain the trend towards externalization in the last three decades. Casson, in particular, always saw the processes of internalization or externalization as entirely symmetrical, moving readily from one to the other as the nature of transaction costs shifted in either or both the market or non-market means of coordination of economic activity (see e.g. Casson, 1979). A large part of the explanation for changes in transaction costs within each mode of coordination would be the kinds of changes in the environment which Ietto-Gillies describes. While it is true that transaction cost economics has tended to focus on manager vs. manager or manager vs. shareholder (principal-agent) conflicts, it can also be applied to manager vs. worker conflicts in traditional class or industrial relations terms – Coase’s main original point of reference was the employment contract with a firm. These conflicts can be examined in terms of the scope that exists for rent seeking behaviours within (or beyond) the firm. However, where I do think Ietto-Gillies’s argument is well taken in her discussion of these issues is that the relevant transaction costs of alternative modes may be influenced by pro-active management strategies, and not just by an exogenous shift in the environment beyond the control of any individual decision taker. So strategies have co-evolved with the environment, and the move towards externalization is in part deliberately designed to increase the capture of rents by strengthening bargaining positions. These aspects of active management and the pursuit of power (rents) rather than efficiency (profits) are indeed neglected in most transaction cost approaches in the international business field.
However, in considering the extent to which the established theories of the TNC can be equally well adapted to explain either internalization or externalization, I do see some greater difficulties with the evolutionary approach to internalization originally set out by Kogut and Zander, unless that is thoroughly reworked. Their theory depicts the firm as a social community characterized by certain shared values, which encourages and lowers the costs of internal knowledge transfer (relative to external transfer), and hence promotes the internalization of knowledge development and exchange within the TNC. Yet we now appreciate that social groups or communities (business networks) can often be formed successfully externally as well as internally, as argued at least implicitly above with reference to the new definition of a TNC as a coordinator of international business networks with both internal and external elements. Indeed, contemporary social network analysis has more often adopted such a person-based rather than a strictly organization-based notion of ties in assessing network relationships. So while conventional internalization theory can readily be inverted to become a theory of externalization, this is not so evidently the case with Kogut and Zander’s more sociological interpretation of the logic for internalization. One can of course depict functioning business networks as social groups or communities, but generalizing this approach to potentially apply equally to internal or external networks challenges the Kogut and Zander interpretation of the firm as a kind of privileged social community. If we try and avoid this difficulty by re-defining the TNC (like above) to consist of close social ties rather than the ownership of assets, then it might be objected that we would run into the same sorts of worries over tautology as have plagued the transaction cost version of internalization theory. The question would become the conditions under which close social ties and shared values come about externally as well as internally. Indeed, once we start down this route there is no reason on the other side of the story to suppose that social ties and shared values always exist or work well internally, especially in large and geographically disparate TNCs. Moreover, as noted earlier, social groups may still contain divergent interests, and so the original Kogut and Zander story tends to downplay the existence of potential intra-group conflicts and rent seeking (on the relevance of which, see Mudambi and Navarra, 2004), aspects that would follow more naturally from transaction cost reasoning even if these accounts of the existence of the TNC have often been somewhat narrower in character than might have been appropriate (as just discussed above).
Turning to the eclectic paradigm or OLI framework, I think that Ietto-Gillies misses an important distinction between Dunning’s concept of ownership advantages and what later were called (by Rugman and others) firm-specific advantages. Ietto-Gillies follows a common belief that ownership advantages and firm-specific advantages are equivalent, which belief I suspect came about around the time that attention shifted in international business scholarship from the country level to the firm level, as I described earlier. Yet both Dunning and Vernon had a notion of TNC capabilities that incorporated some collective elements in their home country of origin. The term ownership advantages is the shortened version of what Dunning had called the ‘advantages of the nationality of ownership’. In other words, he intended to refer not to the ownership of assets (another common mistake) but to the advantages associated with having emanated from some specific home country. These would therefore include capabilities accessed through inter-organizational networks in the home country, and access to home country institutions, as well as capabilities held in-house in the TNC itself (firm-specific advantages). While in the internalization era there seemed little need to emphasize this distinction, in the contemporary period of externalization Dunning’s distinction becomes ever more vital and prescient, since capabilities are held in business networks and not just in in-house facilities. Likewise, location advantages are not just host country advantages, but refer to resources and capabilities associated with any unit of observation of a host location, as appropriate to the context examined – sometimes a sub-national region, or a cross-national region like the EU. I will come back to this issue in considering Ietto-Gillies’s discussion of the role of the nation state in international business below.
Another aspect of the eclectic paradigm that I think is worth emphasizing is its flexibility and adaptability. This means that the way in which the eclectic paradigm has been interpreted and used over time has changed, and indeed has undergone more than one transformation as it has evolved (see e.g. Eden and Dai, 2010). Critics of the eclectic paradigm have often seen this versatility of the eclectic paradigm and its theoretical openness as a weakness, but in my view it has actually been its greatest strength and the reason for its continued centrality in the international business field. Originally, the chief objective of the eclectic paradigm was to provide a synthesis of the various economic theories of international business, and a framework within which they could be compared on some common ground where they offered genuinely competing explanations of a common phenomenon. Although it was probably unanticipated at the time, the eclectic paradigm is sufficiently general in nature that it has continued to fulfill a similar function but now in a broader analytical context as the domain of international business theory has expanded. Today the eclectic paradigm offers a template for incorporating and relating a wider range of multidisciplinary perspectives and theories on the subject. It serves as the analytical means by which the field is still brought together and becomes more than just the sum of its various disciplinary parts. I am sure that this is a development that would have made Dunning very contented, since he placed great store on shifting the field of international business in a more interdisciplinary direction (Dunning, 1989).
Finally, I come to Ietto-Gillies’s remarks on the role of nation states, which rightly call our attention to the need to re-introduce the political science dimension into the multidisciplinary mix that constitutes our current thinking on TNCs, which has been relatively neglected since the time of Vernon (1971) – although those such as Dunning or Kobrin had been writing especially on governments and international business, and the role of public policies. Recent work by those like Henisz, Makhija or Cuervo-Cazurra has been linking TNC strategies to their interactions with governments and political structures, which has dovetailed quite nicely with more sociologically-grounded work on institutions and international business. So in one sense I suspect that Ietto-Gillies is here pushing at an open door into a branch of international business theory development in which a process of revival seems to be already under way and which is likely to draw in further research interest in the near future.
However, although it is certainly true that the borders between countries are political boundaries, I do think that it oversimplifies matters from an international business perspective to think of the crossing of borders by the TNC merely in terms of encountering a different governmental, regulatory and policy regime. Countries and regions of the world have been separated by the barriers of geographical distance for so long in history, constraints of distance that have only gradually begun to diminish over the past few hundred years, and especially since the transport and communications revolutions of the mid-19th century that Ietto-Gillies mentions. From this longer term perspective the emergence and growth of nation states in this same historical epoch since the Middle Ages is a reflection of these by now inherited human and cultural boundaries, rather than the reason for them. What those of us also in the innovation studies field call national systems of innovation are differentiated not just because the system of government and regulatory structures are distinct, but because of a range of other associated formal institutions, and an even more complex set of informal institutions or ways of doing business. The connections between firms, and between firms and non-firm actors vary greatly across countries, and not just for the reasons of the specificities of government policy and regulation. It can be argued e.g. that the reason inward FDI penetration in Japan is so low for its level of economic development has little to do with formal barriers or regulatory constraints on foreign enterprise, but rather with distinctive ways of doing business and forming inter-organizational network relationships that are often misunderstood or misinterpreted by Western firms. Moreover, as alluded to in passing earlier, once we mention national systems of innovation we come naturally as well to the role as well of regional systems of innovation, both at the sub-national level and at the supra-national level. While each of these levels of regional entity also have their administrative authority structures, they too are not fully described as locational units by these political and regulatory features. So although Ietto-Gillies is certainly right to ask us to bring the role of states more into our discourse, in my view it overstates matters to say that this is the only aspect of locational variety encountered by TNCs which is not experienced also by purely domestic firms. As geographical distance rises, so does institutional variety and differences.
Therefore, I would argue that TNCs need to be understood not just in the context of nation states, but more generally in the context of locational diversity of various kinds (including differences in political and regulatory environments), in which the degree of locational diversity across countries is of a qualitatively different order of magnitude to that experienced by domestic firms, even in a large country. For international business and in particular for the innovative TNC the main reason why this matters is due to the far greater diversity in the settings encountered for interaction with local capabilities across locations, and in the distinct nature of those locally differentiated capabilities. Operating in such a diverse set of environments, in different national systems of innovation, provides TNCs with the opportunity to create more diverse kinds of knowledge, and to discover a much broader range of new combinations of knowledge. This brings us back to my earlier discussion of the change in the nature of the TNC itself as an actor, since TNCs are distinguished from other firms by what Kogut and Zander called their combinatorial capabilities, and these have gradually enabled them to serve increasingly as system integrators across international networks that connect a series of other actors each with very different kinds of knowledge and capabilities. So as Ietto-Gillies rightly remarks, our notion of TNC strategy should not be confined to rivalrous interactions with others, but must increasingly recognize and emphasize strategies with respect to cooperative relationships in local and international business networks (including those with non-firm actors), and how as she suggests these may in turn be a major source of advantages relative to a TNC’s major competitors.
Casson, M.C. (1979), Alternatives to the Multinational Enterprise, London: Macmillan.
Dunning, J.H. (1989), “The study of international business: a plea for a more interdisciplinary approach”, Journal of International Business Studies, 20(3), 411-436.
Dunning, J.H. and Lundan, S.M. (2008), Multinational Enterprises and the Global Economy, second edition, Cheltenham: Edward Elgar.
Eden, L. and Dai, L. (2010), “Rethinking the O in Dunning’s OLI/eclectic paradigm”, Multinational Business Review, 18(2), 13-34.
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Iammarino, S. and McCann, P. (2013), Multinationals and Economic Geography: Location, Technology and Innovation, Cheltenham: Edward Elgar.
Ietto-Gillies, G. (2012), Transnational Corporations and International Production: Trends, Theories, Effects, Cheltenham: Edward Elgar.
Mudambi, R. and Navarra, P. (2004), “Is knowledge power? Knowledge flows, subsidiary power and rent-seeking within MNCs”, Journal of International Business Studies, 35(5), 385-406.
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Thank you for taking the trouble to read carefully and respond to my paper The Theory of the Transnational Corporation at 50+. Your comments greatly add to my contribution by deepening the discourse. Here I take the opportunity to add some comments and clarifications to yours.
You start your comments with very interesting methodological remarks about the trajectory of the international business (IB) literature after its starting point from – or very closely to – economics. I very much agree with you on the positive role played by multi- and inter-disciplinarity in the development of the subject. Indeed I would go further in saying that these developments need not be specific to IB only. I believe that other parts of economics would greatly benefit from liaisons with other disciplines particularly sociological and political sciences. They would also benefit from more grounded links with empirics and from the use of a wider variety of methodologies.
We both agree that the trends towards externalization need new approaches to the firm and particularly to the TNC. Dunning and Lundan (2008) work is a good example of authors aware that old approaches may no longer suffice. Years ago Cowling and Sugden (1987:12) saw the need for a redefinition of the firm and the TNC on the basis of their control over units which are external in terms of ownership but are nonetheless dependent on the principal firm. They give the following definitions: ‘A firm is the means of coordinating production from one center of strategic decision-making. A transnational is the means of coordinating production from one center of strategic decision-making when this coordination takes a firm across national boundaries. This part of their work was further developed in their 1998 article.
I agree with you that the proponents of the Internalization Theory saw as symmetrical the process of internalization versus externalization. After all, in a static sense, internalization implies that, at the micro level, there is another choice and there always was. However, my criticism stems from historical developments at the macro level. Yes, managers always had the choice between growth via internal activities or via external ones such as licensing or sub-contracting. But the fact remains that, historically, there was a tendency towards internalization up to the early 1970s (and this, in my view, helps to explain why the theory was developed at that point in time). However, the trend was reversed dramatically from the 1980s onwards. Given that the managers were always faced with the same choices, how do we explain the two different trends? In my view they can only be explained by bringing in external socio-political elements. The increased internalization combined with other socio-economic factors led to a more powerful workforce in the late 1960s and early 1970. As a reaction to this, firms and indeed public institutions moved towards subcontracting and other externalization modalities. This contributed to weaken the bargaining power of labour as we see today.
In discussing internalization you introduce some poignant comments on Kogut and Zander (1993)’s evolutionary theory. I would, once again, like to use external, historical trends to further support your point. The political and economic contexts of the last three decades have brought about several changes including the following two related to both the private and public sectors. First, labour has become more mobile in two different meanings. The gradual erosion of secure and stable employment contracts means that labour has become more mobile across firms and sectors. It has also become more mobile across countries, which is one of the characteristics of globalization. As skilled labourers moves across institutions, sectors or countries they form wider networks. Second, universities and public research centres have been told for years that a measure of their success is the ability to forge links with private producers. Whether this is conducive to better research or not, the fact is that, increasingly, companies’ skilled labour has the opportunity of networking with public researchers. All this points to the increasing relevance of networks that span outside the boundaries of the firm. Thus Kogut and Zander’s idea of the firm as the hub of exclusive, privileged networks may be undermined by the empirics of historical trends.
One last point I would like to make refers to the role of nation-states in my approach to the explanation of TNCs’ strategies and activities. Yes, the nation-state and the role of governments have often been included in IB writings: from Hymer post-dissertation work to Vernon to Dunning. In more recent writings the emphasis on policies of attractiveness (of inward FDI) necessarily implies a role for the State and its government. However, my point is not so much about policies of single States and the politics behind them important though these are. The key point in my discourse is the fact the actors that can plan, organize and control across frontiers – as the TNCs can – have a bargaining advantage when dealing with actor who cannot do so or not to the same extent. Thus the ex-ante contractual power of TNCs is considerable stronger than that of the workforce they confront in each country or of governments that try to outbid each other in sweeteners or suppliers who are often location bound. It is multinationality per se that gives advantages to the TNCs. The bargaining power over these three sets of actors can be turned into market power. There can be also further advantages of multinationality including risk spreading and learning from the diverse innovation environments of different nation-states. The latter is a field to which you have made a major contribution. For these reasons the theory of the TNC cannot be just an extension of the theory of the firm in general or of the big firm in particular. The different regulatory regimes of nation-states lead to situations that require a qualitative different approach from the theory of the firm. The stress on advantages of multinationality has policy implications: for the labour movement it implies building bridges across frontiers and avoiding the games of setting Poles against Italians or British against Rumanians. The other relevant policy implication may be related to separatist movements which are springing up everywhere be it Scotland, Northern Italy or Cataluna. Why devolution of some powers from the centre may be in the interest of regions and countries, the main beneficiaries of full separation may end up to be the TNCs as they will have more policy centres – i.e. more nation-states – in competition with each other. I recently read in the British press that one of the pledges of the aspiring separate Scotland will be to lower corporation tax in competition with the one – already quite low – of Britain.
You point out the role of cultural differences. I do not consider them in the paper under discussion though there is a small role for them in the relevant chapter -14 – in my book. I agree that cultural issues should play a bigger role. However, the tremendous increase in cross country FDI in the last few decades is testimony that cultural barriers can be overcome. Inward FDI into Japan may have been constrained by cultural factors; however, had other conditions been favourable – such as government policies – the cultural barriers would have been overcome. Cultural distance is only part of the story. After all Japanese companies coming from a different culture managed to overcome the barriers and successfully expand their FDI abroad. Why could not Western companies overcome the cultural distance – if that had been the only or main problem – and invest in Japan? Moreover, cultural barriers can often be overcome by joint ventures, a modality of internationalization more appealing to host countries as well as of help to the foreign firm in learning about a new cultural and institutional environment.
Cowling, K. and Sugden, R. (1987), Transnational Monopoly Capitalism, Brighton: Wheatsheaf.
Cowling, K. and Sugden, R. (1998a), ‘The essence of the modern corporation: markets, strategic decision-making and the theory of the firm’, The Manchester School, 66 (1), 59–86.