Module Name : Global Shift

Banner Code : 07 21330

Teaching Staff : Paulina Ramirez

Assignment Title:

Analyze and critically evaluate dunning’s eclectic paradigm to what extent

does this paradigm help understand the FDI flows into EU

Submitted by : ID–982450(MSc International Business)

Word count : 2999
International production and FDI are trends associated mostly with multinational companies
(MNC’s) which form the base for international business studies. In today’s global
environment, the understanding of these trends and its accurate application defines the
profitability and success among international business players.

JH Dunning has provided a unique concept of International Production with his Eclectic
Paradigm and this paper analyses and critically evaluates it. The other objective of this paper
is to provide an understanding on International production and FDI (Foreign Direct
Investment), also using insights from Eclectic Paradigm to help understand FDI flows into
the European Union (EU).

Foreign Direct Investment (FDI)

One must understand profitability and expansion are the top priorities of any business to
function and gain foothold. FDI is a sophisticated entry mode to a newer market and provides
greater control and presence but is most risky due to problems related to unfamiliar
environment and expensive due to cost of establishing production facility as well (Luo, 2002,
p. 203). FDI is one of the key fundamental activities of MNC’s which help the firm grow
internationally (Rugman, 2009, p. 5) and provides cheaper production facilities and maybe
even access to better technology and skills which open up global horizons for a firm to enter
newer markets giving efficient output on capital invested (Graham & Spaulding, 2005).
International production thus cuts across borders and is advantageous as benefits from global
access to goods and services with international exports and concessions come in. The reasons
motivating FDI are now known but FDI’s are normally not uniform with varying FDI flows
for different regions/ countries around the world. FDI flows are calculated using both inward
(inflow - to the destination or host country) and outward (outflow – from the home country)
movement of the capital. Management consultants like AT Kearney rate the viability of FDI
destinations every year or so, with mostly developing nations, especially China and India,
topping the rankings but even USA and UK remain very strong contenders (Herring, 2007)
(India, China top FDI destinations: Report). Thus understanding a framework to
determine the attractiveness of a market for FDI can be well analysed using the Eclectic
Paradigm.
Eclectic Paradigm

‘Eclectic’ means selecting or choosing from various sources (Dictionary.com, 2009) and
Paradigm means an example serving as a model; pattern (Dictionary.com, 2009). Hence
Eclectic Paradigm of International production is a pattern or platform which has been formed
using various sources. According to John H Dunning (Cantwell & Narula, 2003, p. 25) it
can be explained as: -

Dunning’s Eclectic Paradigm also called the OLI Model of international production is a
tripod explaining the range and topography of value added activities performed by MNC’s. It
was first put forward by him in 1976 after evaluating US manufacturing affiliates in the UK
and it has since been utilised appropriately worldwide. The three major legs of the tripod are
Ownership (O), Location (L) and Internalisation (I) advantages for a firm. The paradigm
states that a firm will engage in FDI when all these conditions are present.

1. The Ownership advantages (O): - Ownership advantages can be linked to firm

specific advantages (FSA) or the competitive advantages which a firm possess and are
generally the key sources to its success in its home base. Extensions of these
advantages play an important role to develop competency in foreign bases. These
maybe the tangible or intangible assets which support the firm’s capabilities. The
tangible assets include the resource base (Rugman, 2009, p. 45) and intangible assets
include technology, brand name, benefits of economies of scale along with
evolutionary management and organizational skills (logistics, marketing skills)
(Investments and Income, 2007). These advantages bring benefits of higher
revenues and lower cost to compete with foreign firms in their own market.
2. The Location Advantages (L): - Location advantages are defined as the extent to
which the complementary assets and services which are indigenous to the location
(host country) can be augmented with the Ownership advantages (of the firm from
home country) (Rugman, 2009, p. 45) to enhance profitability. Location advantages
of any host country vary with time as attractiveness of the host country is subject to
change due to competitiveness. This is what defines the ratings previously discussed
and is an important factor in determining the FDI flow to a country. It may also seem
of interest that these advantages are in turn dependent on the economic environment
(quality and quantity of overall infrastructural facilities and market), political
environment (policies and regulatory environment for FDI and International
 Production) and Social, Cultural environment (language, understanding between
business environments, respect for local attitude). (Investments and Income, 2007)
3. The Internalisation Advantages (I): - Internalisation advantages define the inclination
of a firm to FDI to realise both O and I advantages thus adding value to them.
Internalisation is attractive where the market does not exist or is imperfect leading to
high transactions expenses of the external route. (Investments and Income, 2007)
The firm must benefit from controlling the foreign business activity, rather than
licensing or franchising to a local player to provide the service.

Source: - (Stoian & Filippaios)

Analysis and Evaluation

In the OLI or Eclectic Paradigm the O advantages explain why a firm may go abroad so as to
utilize its firm specific advantages and play a significant role in the newer market by using its
competitiveness to counterbalance its cost for operating at a distance. Thus it remains
successful in maintain its profits and finding leverage over its local competitors. These
advantages are not always constant and continuous innovation is required to maintain such a
lead. Also these advantages may vary depending on whether a firm is small or MNC. The L
advantages explain where a firm needs to set up its international production unit to gain
maximum productivity at lower costs. The I advantages explain how the firm enters a foreign
location outlining the most attractive way depending on the conditions prevailing at the
location. Thereby avoiding imperfections (high transaction costs, no information on products)
and capitalising on advantages (tax concessions and subsidies). (Eden, 2003)

The intensity of the OLI advantages is directly proportional to the tendency of a firm to adopt
an FDI entry mode to a foreign market. Even though the OLI model is eclectic and its basic
ideas are supported by several empirical studies undertaken by Dunning and each of the
advantages discussed in Eclectic Paradigm is significant but the configuration is bound by
specifics related to industry (for ownership and value added activities), country or region (for
location) and inters-firm and intra-firm business dynamics (for internalisation). The inter
relation between these factors, like between a specific firm to a specific location or a specific
industry to a specific location may be entirely dissimilar and diverse. (Cantwell & Narula,
2003, p. 28) For example: - Suzuki having a manufacturing base in India but BMW doesn’t,
and prefers European or North American manufacturing bases.

The Eclectic Paradigm is being modified and updated according to inputs received from
various scholars and also due to ever changing business environment (Rugman, 2009, p. 45)
and intends to explore all important factors impacting entry mode decisions but the fact is the
original Dunning’s OLI falls short due to the ignoring of strategic factors, characters and
situations surrounding the decision, increasing competition and changing demographics.
Newer suggestions to incorporate these factors along with other factors such as international
financing for international production (foreign currency exposure, currency unions),
integrating insights from institutional theories (liability of foreignness, public corruption, etc)
will lead to broadening of the Eclectic Paradigm. (Eden, 2003)

Understanding FDI flows in European Union (EU) using insights from Eclectic
Paradigm

FDI flows in EU need to be understood at two levels, i.e., extra-EU and intra- EU.

1. Extra-EU: - When FDI inflow and outflow is between a member country of EU and
any country outside EU.
2. Intra-EU: - When FDI inflow and outflow is between within two member countries of
the EU.
More recently the focus of attention has been analysing the Intra-EU FDI flows which have
been growing at a good rate (Econocmists Advisory Group Ltd, 1996).The European Union
represents the world's biggest investor. EU both owns and hosts 33.33% of world FDI stock
when intra-EU investments are removed from the total and 50% when they are included.
Intra-EU investments represent 34% of world stocks ($3,500bn out of a total of $10,000bn).
When intra-EU investments are excluded, EU stocks of outward investments amount to
$2,200bn (33% of world stocks). Also, EU inward investments amount to $1,900bn (29% of
world total) (European Commision, 2006)

As analysed before OLI paradigm, takes into account the Ownership (O), Location (L) and
Internalisation (I) advantages to deliver FDI attractiveness and major Improvements in the
institutional framework, political stability and the prospects for European Union (EU)
membership have acted as important catalysts for Foreign Direct Investment (FDI) attraction.

To attract FDI and business, countries such as Serbia have the lowest corporate income tax
rate in the region of only 10%, the lowest standard value added tax of 18%, and one of the
lowest salary taxes of 12%. Besides Bulgaria, and Macedonia, which also have corporate
profit tax rate of 10%, other countries in the region have much higher rates (Romania and
Hungary 16%; Slovakia and Poland 19%; Croatia 20%; and the Czech Republic 24%).
Recently, Macedonia took initiative to become "New Business Heaven in Europe" by
offering substantial investment incentives for foreign investment in so-called Free Economic
Zones (FEZ) and technology parks. Among other incentives, it offers foreign investors no
corporate tax for 10 years, and 10% thereafter within FEZs (Stefanović, 2008). Incentives
likes these along with infrastructural developments by the government can be related to the
OLI paradigm’s location determinants which will accelerate FDI in these countries and
negate effects of high political and social risks.

A report published in 2005 also gives an idea of the trends which are changing in favour of
Eastern European Countries as being a part of EU has benefited much. The Ernst &Young
Investment Monitor, which tracks projects already realised, shows that the UK and France
managed to maintain their positions as the top FDI destinations in Europe. But Poland and
Hungary are now among the top five, with the former barely behind third-ranking Germany
in terms of market share. Taken together, central and eastern European countries (including
Russia) tapped an impressive one third of world investment in Europe in 2004. he
combination of cheap and often highly skilled labour, low taxation and attractive incentives is
changing perceptions of the newly developing economies of central and eastern Europe. Also
to be noticed from the same report is that, World companies are no longer investing so much
in production but in sophisticated services and R&D. Companies investing in technological
centres (R&D units for the conception and production of innovative products) can obtain
subsidies covering half of investment costs for up to 10 years in the Czech Republic. The
Ownership and Internalisation advantages are being realised to obtain maximum advantage
and gain from local knowledge base available to innovate. (Upward trends in eastern
Europe, 2005)

Furthermore EU has the advantage of economic integration along with monetary integration
leading to strong trade and FDI flows and as countries are more closely linked it will lead to
synchronisation of their business cycles. Hence eventually directing to the lower costs of
customs, virtually no exposure to exchange rate fluctuations (if intra-EU) and removed trade
barriers. Having a common currency Euro provides a stability oriented monetary, fiscal and
structural policy in Europe. (Liebscher, 2007, p. 4)

Looking Forward, FDI inflows though continue to be attracted most by countries such a
UK, Denmark, France and Germany due to their favourable positions in the past, political,
social and financial stability and well developed and evolved infrastructure and business
systems but there is emergence of the newer member who are competing with these
developed nations and are gaining more share in the FDI market. Countries like Bulgaria,
Czech Republic and other low cost but high knowledge bases in Eastern Europe are have
reported strong FDI growths based on their continuous efforts to betterment of OLI
advantages prospects for their investors.

Bibliography
(2009). Retrieved August 10, 2009, from Dictionary.com:
http://dictionary.reference.com/browse/eclectic

(2009). Retrieved August 10, 2009, from Dictionary.com:

http://dictionary.reference.com/browse/paradigm
Cantwell, J., & Narula, R. (2003). International business and the eclectic paradigm: developing the
OLI framework. Retrieved August 10, 2009, from Google Books: http://books.google.co.uk/books?
id=NCwb-nv2zvoC&pg=PA25&lpg=PA25&dq=what+is+Dunning
%E2%80%99s+Eclectic+Paradigm+of+International+Production&source=bl&ots=nCkD_HK4fv&sig=by
ObjOzrJZwTNthuwSrPujte_xo&hl=en&ei=2b2GSpmkL-LOjAf5wPCiCw&sa=X&oi=book_result&ct=res

Econocmists Advisory Group Ltd. (1996, October). FOREIGN DIRECT INVESTMENT. Retrieved August
10, 2009, from The Single Market Review Series: http://ec.europa.eu/internal_market/economic-
reports/docs/studies/stud11_en.pdf

Eden, L. (2003). A critical reflection and some conclusions on OLI. Retrieved August 10, 2009, from
http://www.voxprof.com/eden/Publications/Eden-Reflections-on-OLI-2003.pdf

European Commision. (2006). EU performance in the Global Economy. Retrieved August 10, 2009,
from Global Europe: http://trade.ec.europa.eu/doclib/docs/2008/october/tradoc_141196.pdf

Graham, J. P., & Spaulding, R. B. (2005). Understanding Foreign Direct Investment. Retrieved August
10, 2009, from Going Global: http://www.going-
global.com/articles/understanding_foreign_direct_investment.htm

Herring, R. (2007). China, India Still Top FDI Spots. Retrieved August 10, 2009, from Red Herring:
http://www.redherring.com/Home/23304

India, China top FDI destinations: Report. (n.d.). Retrieved August 10, 2009, from The Financial
Express: http://www.financialexpress.com/news/india-china-top-fdi-destinations-report/249923/

Investments and Income. (2007). Retrieved August 10, 2009, from

http://www.investmentsandincome.com/investments/oli-paradigm.html

Liebscher, K. (2007). Foreign direct investment in Europe: a changing landscape. Retrieved August
10, 2009, from Google Books: http://books.google.co.uk/books?
id=4RqQGesjmNQC&pg=PA5&lpg=PA5&dq=common+currency+effects+on+FDI+inflows+into+EU&so
urce=bl&ots=ryUQ86O8n5&sig=0QAhWEBxx5QeZaJN7LC45KTzMqs&hl=en&ei=8qqLStypBKSQjAfDzf
Fi&sa=X&oi=book_result&ct=result&resnum=3#v=onepage&q=&f=f

Luo, Y. (2002). Multinational Enterprises in Emerging Markets. Retrieved August 10, 2009, from
Google books: http://books.google.com/books?
id=G_RlwpxlBVwC&pg=PA198&dq=modes+of+entry&ei=9p6KSon8C6GozQTVioTgDQ#v=onepage&q
=&f=false

Rugman, A. M. (2009). The Oxford Handbook of International Business. Retrieved August 10, 2009,
from Google Books: http://books.google.co.uk/books?id=QZhWwTO-
jRcC&pg=PA1&dq=The+Oxford+Handbook+of+International+Business++By+Alan+M.
+Rugman#v=onepage&q=&f=false

Stefanović, S. (2008). ANALITICAL FRAMEWORK OF FDI DETERMINANTS:IMPLEMENTATION OF THE

OLI MODEL. Retrieved August 10, 2009, from Faculty of Economics, University of Niš, Trg kralja
Aleksandra Ujedinitelja 11, Serbia: http://facta.junis.ni.ac.rs/eao/eao200803/eao200803-07.pdf
Stoian, C., & Filippaios, F. (n.d.). Foreign direct investment in Central, Eastern and South Eastern
Europe: an ‘eclectic’ approach. Retrieved August 10, 2009, from
http://www.inderscience.com/StoianAndFilippaios.pdf

Upward trends in eastern Europe. (2005, October 03). Retrieved August 10, 2009, from FDI
Magazine:
http://www.fdimagazine.com/news/fullstory.php/aid/1437/Upward_trends_in_eastern_Europe.ht
ml