Thalasar Ventures

INVESTMENT THEORY

There are a number of investment theories.  Except for MacDougall hypothesis, investment theories are primarily based on imperfect market conditions. A few of them are based on imperfect capital market.

MacDougall-Kemp Hypothesis:    Assuming a two-country model- one being the investing and other being the host country and the price of capital being equal, the investment flows from abundant economy to a capital scare economy until the marginal productivity of capital in both the countries are equal or till the returns from investment is greater than the loss of output in home country.

http://www.govindam.org/

Industrial Organisation Theory : The theory is based on oligopolistic or imperfect market in which the investing firm operates. Market imperfection arises in many cases, such as product differentiation, market skills, proprietary technology, managerial skills, better access to capital, economies of scales, government imposed market distortion and so on.  Such advantages confer MNCs an edge over their competitors in foreign locations and thus helps in compensate the additional cost of operating in an unfamiliar environment.  It refers to technological and similar other advantages possessed by a firm that enable it to produce new and differentiated products.

Location Specific Theory : This theory is compounded by hood and Young.  It refers to advantages like cheap labour, abundantly available raw material, and so on for the production of a commodity to be established in a particular location or country.  Since real wage cost varies among countries, firms with low cost technology move to low wage country.

Product Cycle Theory : Raymond Vernon feels that most product follow a life cycle that is divided into three stages :

(a)   Innovation  Stage:  It is a stage in the product cycle when the product is in demand because of its new and improved quality, irrespective of its price.  The product is manufactured in the home country primarily to meet the domestic demand but a portion of the output is exported to the other developed countries.

(b)   Maturing Product Stage :   At this stage, the demand for the new product grows and it turns price elastic.  Rival firms in the host country begin to supply similar product at a lower price owing to lower distribution cost, whereas the product of innovator is costlier as it involves transportation cost and tariff that is imposed by the importing government.  Thus to compete with the rival firms, innovator decides to set up a production unit in host country itself which would lead to internationalization of product.

(c)   Standardised Product ; It is the stage in the product cycle when technology does not remain the exclusive possession of innovator and competition turns stiffer.  At this stage price competitiveness becomes even more important and the innovator shifts the production to a low cost location, preferably a developing country where labour is cheap.

(d) Denaturing Stage : It is the stage when development in technology or in consumer’s preference breaks down product standradisation.  Cheap labour does not matter at this stage as sophisticated model involves a capital intensive mode of production.

http://www.govindam.org/

Internalization Approach :  Buckley and Casson too assumes market imperfection, but imperfection in their view, is related to transaction cost that is involved in intra-firm transfer of intermediate product such as knowledge or expertise.  It is internalization benefit is cost free intra-firm flow of technology development by the parent unit.

Currency Based Approaches :  It is compounded by Aliber. Such theories are normally based on imperfect foreign exchange and capital market.  The theory postulates that internationalization of firms can best be explained in terms of the relative strength of different currencies.  Firms from strong currency country moves to a weak currency country.  In a weak currency country, income stream is fraught with greater exchange risk.  As a result the income of strong currency country firm is capitalized at a higher rate.

Politico-Economic Theories :  These theories concentrate on political risk.  Political stability in the host country leads to foreign investments.  Similarly, political instability in the home country encourages investment in foreign countries.

Modified theories for Third World Firms : Developing country MNCs posses firm specific advantages in form of modified technology.  They move abroad also to reap advantages of cheap labour and abundance of natural resources.  These firms have long been importing technology from industrialized countries.  But since imported technology is mainly designed to cope with a large market, firm export a part of their   output after meeting their domestic demand.

http://www.govindam.org/