The Essence of the MNE and Hymer’s Thesis

Before Hymer, many economists viewed the MNE as simply an arbitrageur of capital, transferring equity capital from countries where returns were low to those where it was higher, earning the arbitrageurs rents and contributing to efficient resource alloca- tion. The capital arbitrage theory of the MNE predicted the MNEs would be headquartered in countries where the domestic marginal productivity of capital was relatively low, from which they will transfer capital to subsidiaries where the marginal productivity was higher.6

As Hymer (1976) first observed, however, there are several fea- tures of direct foreign investment (DFI) and the MNE which are inconsistent with this theory. The MNEs overwhelmingly finance their host-country operations in host-country capital markets. Furthermore, there are substantial cross-flows of direct foreign investment, as well as substantial concentration of DFI in particular industries. These observations would be consistent with a capital arbitrage theory only if domestic capital markets were highly balka- nized, which they generally are not.

In searching for a plausible theory of DFI, Hymer’s primary tenet was that DFI was motivated by domestic firms’ attempts to increase the returns from the utilization of firms’ special advantage (Hymer, 1976: 33).7 Hymer suggested that the sources of the advantage could be in product market power, superior production techniques, and imperfections in input markets (which allow lower buying prices for incumbent firms), and first-mover advantages. Possessing such special advantages, a national firm could be profitable outside the home country despite the higher costs resulting from its relative ignorance of local conditions abroad.

What made Hymer’s thesis appealing was its apparent predictive power. Hymer showed that foreign direct investment tended not to occur in those industries best approximated by perfect competi- tion. Rather, direct foreign investment was clustered in (i) natural resource industries and (ii) industries where there was some sig- nificant level of industry concentration.8

Hymer’s insights laid the foundation for a new paradigm of the multinational enterprise. Admittedly, there was not much if any- thing in place at the time that might be characterized as a theory of the MNE. Hymer’s key contribution was to transport the theory of direct foreign investment out of international trade and finance and into industrial organization and the theory of the firm.

Unfortunately, the field of industrial organization at the time he was writing (c .1960) did not have quite the richness  it  has today, and was dominated by monopoly rather than efficiency explanations of business behavior and complex organizational forms.9 Furthermore, the library of concepts from which Hymer could borrow was especially sparse with respect to the eco- nomics of new organizational forms. His crude approach to the MNE reflected this rather crude state of understanding of com- petition policy and what Coase has referred to as the “inhos- pitability tradition” that prevailed in antitrust economics at the time.10

Hymer was furthermore handicapped by the absence of real- istic welfare criteria for evaluating the MNE. In the absence of alternatives, Hymer seized upon perfect competition as his bench- mark. However, perfect competition is an unrealistic and imprac- tical policy benchmark; so Hymer inevitably arrived at awkward policy recommendations. He saw the raison d’être of the MNE as stemming from the “impurities of the market [that] would not arise in competitive industries” (1976: 86). This led him to the conclu- sion that “a restriction on direct investment or a policy to break up multinational corporations may be in some cases the only way of establishing a higher degree of competition in that industry— the underdeveloped countries need to devote an important share of their scarce resources to building up national enterprises . . .” (Hymer, 1970: 444).

However, if an MNE possesses special advantages, then perfect competition simply cannot prevail.11 Perfect competition is rarely a realistic welfare standard. Indeed, there is simply no place for Hymer’s MNEs in the theory of perfect competition. Moreover, the evident failure of national enterprises around the globe and the positive impact that foreign investment and the activities of MNEs have had on economic development is further evidence that Hymer was wrong with respect to this aspect of his assessment of this particular form of business enterprise.

In short, Hymer’s policy error was to view departures from per- fect competition as undesirable market imperfections, and to then conclude that the MNE (being necessarily implicated with markets in which competition was imperfect) must be instruments of perni- cious market power.12 As modern antitrust economics teaches us, there is a substantial gap between finding a market imperfection and finding monopoly or monopolistic competition that would warrant a public policy response.13 Put differently, there is quite some distance between finding monopoly and identifying behavior that warrants legal or public policy intervention and sanctions. In this regard, Hymer’s analysis is at odds with the teachings of modern competitive economics, and also with competition policy.

Despite these shortcomings, there is no doubt that Hymer’s work represents a major contribution to the positive economics of the multinational enterprise. At the same time, it is important to recognize that his theory of the MNE is misdirected in its heavy emphasis upon market power as the explanation for the global expansion of firms. As indicated below, MNEs need to develop unique assets/resources and capabilities to be successful. (This is a basic point accepted by Hymer.) This leads to some degree of uniqueness in the MNE’s product or service offerings. Accordingly, the individual MNE’s demand curve is unlikely to be horizontal, and in that sense MNEs will all have “market power”; but as noted above, such market power is unlikely to be troublesome from a competition policy perspective. Rather, it is likely to reflect the fact that the firm has something unique to offer in domestic and for- eign markets, possibly leveraging technology and other intangibles. Such uniqueness is likely to be an indicator of the desirability of direct foreign investment.

Source: Teece David J. (2009), Dynamic Capabilities and Strategic Management: Organizing for Innovation and Growth, Oxford University Press; 1st edition.

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