INTERNATIONAL TRADE THEORIES

International Trade Theory deals with the different models of international trade that have been developed to explain the diverse ideas of exchange of goods and services across the global boundaries. The theories of international trade have undergone a number of changes from time to time. The basic principle behind international trade is not very much different from that involved in the domestic trade. The primary objective of trade is to maximize the gains from trade for the parties engaged in the exchange of goods and services. Be it domestic or international trade, the underlying motivation remains the same. The cost involved and factors of production separate international trade from domestic trade.

International trade involves across border exchange and this increases the cost of trading. Factors like tariffs, restrictions, time costs and costs related with legal systems of the countries involved in trade make the international trade a costly affair; whereas the extent of restrictions and legal hassles are considerably low in case of domestic trade.

When it comes to the comparison between international trade and domestic trade, the factors of production assume a crucial role. There is no denying that mobility of factors of production is less across nations than within the domestic territory. The incidence of trade in factors of production like labor and capital is very common in case of domestic trade; while in case of international trade exchange of goods and services contributes the major share of the total revenue.

International trade theory has always been a preferred field of research amongst the traditional and contemporary economists. The international trade models attempt to analyze the pattern of international trade and suggest ways to maximize the gains from trade. Among the different international trade theories, the Ricardian model, the Heckscher-Ohlin model and the Gravity model of trade are worth mentioning.

The Ricardian model of international trade is developed on the theory of comparative advantage. According to this model countries involved in trade, specialize in producing the products in which they have comparative advantage.

The Heckscher-Ohlin model put stress on endowments of factors of production as basis for international trade. As per this theory countries will specialize in and export those products, which make use of the domestically abundant factors of production more intensively than those factors, which are scarcely available in the home country.

The Gravity model of trade provides an empirical explanation of international trade. According to this model, the economic sizes and distance between nations are the primary factors that determine the pattern of international trade.

The international trade theories also deal with challenges before international trade, international trade laws, rules of international trade and many other related issues.

The various trade theories are:

Absolute cost theory Comparative cost theory

Factor proportion theory

PLC theory

Country similarity theory

Opportunity cost theory

ABSOLUTE COST THEORY:

In economics, principle of absolute advantage refers to the ability of a party (an individual, or firm, or country) to produce more of a good or service than competitors, using the same amount of resources. Adam Smith first described the principle of absolute advantage in the context of international trade, using labor as the only input.

Since absolute advantage is determined by a simple comparison of labor productivities, it is possible for a party to have no absolute advantage in anything; in that case, according to the theory of absolute advantage, no trade will occur with the other party.It can be contrasted with the concept of comparative advantage which refers to the ability to produce a particular good at a lower opportunity cost.

The main concept of absolute advantage is generally attributed to Adam Smith for his 1776 publication An Inquiry into the Nature and Causes of the Wealth of Nations in which he countered mercantilist ideas. Smith argued that it was impossible for all nations to become rich simultaneously by following mercantilism because the export of one nation is another nation’s import and instead stated that all nations would gain simultaneously if they practiced free trade and specialized in accordance with their absolute advantage. Smith also stated that the wealth of nations depends upon the goods and services available to their citizens, rather than their gold reserves.While there are possible gains from trade with absolute advantage, the gains may not be mutually beneficial. Comparative advantage focuses on the range of possible mutually beneficial exchanges.

COMPARATIVE COST THEORY:

The law of comparative advantage refers to the ability of a party (an individual, a firm, or a country) to produce a particular good or service at a lower opportunity cost than another party. It is the ability to produce a product with the highest relative efficiency given all the other products that could be produced. It can be contrasted with absolute advantage which refers to the ability of a party to produce a particular good at a lower absolute cost than another.

Comparative advantage explains how trade can create value for both parties even when one can produce all goods with fewer resources than the other. The net benefits of such an outcome are called gains from trade. It is the main concept of the pure theory of international trade.

David Ricardo, working in the early part of the 19th century, realised that absolute advantage was a limited case of a more general theory. Consider Table 1. It can be seen that Portugal can produce both wheat and wine more cheaply than England (ie it has an absolute advantage in both commodities). What David Ricardo saw was that it could still be mutually beneficial for both countries to specialise and trade.

Table 1

Country Wheat Wine

  Cost Per Unit In Man Hours Cost Per Unit In Man Hours

England 15 30

Portugal 10 15

In Table 1, a unit of wine in England costs the same amount to produce as 2 units of wheat. Production of an extra unit of wine means foregoing production of 2 units of wheat (ie the opportunity cost of a unit of wine is 2 units of wheat). In Portugal, a unit of wine costs 1.5 units of wheat to produce (ie the opportunity cost of a unit of wine is 1.5 units of wheat in Portugal). Because relative or comparative costs differ, it will still be

mutually advantageous for both countries to trade even though Portugal has an absolute advantage in both commodities.

Portugal is relatively better at producing wine than wheat: so Portugal is said to have a COMPARATIVE ADVANTAGE in the production of wine. England is relatively better at producing wheat than wine: so England is said to have a comparative advantage in the production of wheat.

The simple theory of comparative advantage outlined above makes a number of important assumptions:

There are no transport costs. Costs are constant and there are no economies of scale.

There are only two economies producing two goods.

The theory assumes that traded goods are homogeneous (ie identical).

Factors of production are assumed to be perfectly mobile.

There are no tariffs or other trade barriers.

There is perfect knowledge, so that all buyers and sellers know where the cheapest goods can be found internationally.

Effects on the economy

Conditions that maximize comparative advantage do not automatically resolve trade deficits. In fact, many real world examples where comparative advantage is attainable may require a trade deficit. For example, the amount of goods produced can be maximized, yet it may involve a net transfer of wealth from one country to the other, often because economic agents have widely different rates of saving.

As the markets change over time, the ratio of goods produced by one country versus another variously changes while maintaining the benefits of comparative advantage. This can cause national currencies to accumulate into bank deposits in foreign countries where a separate currency is used.

Macroeconomic monetary policy is often adapted to address the depletion of a nation's currency from domestic hands by the issuance of more money, leading to a wide range of historical successes and failures.

FACTOR PROPORTION THEORY

The Heckscher–Ohlin model (H–O model) is a general equilibrium mathematical model of international trade, developed by Eli Heckscher and Bertil Ohlin at the Stockholm School of Economics. It builds on David Ricardo's theory of comparative advantage by predicting patterns of commerce and production based on the factor endowments of a trading region. The model essentially says that countries will export products that utilize their abundant and cheap factor(s) of production and import products that utilize the countries' scarce factor(s)

Features of the model

Relative endowments of the factors of production (land, labor, and capital) determine a country's comparative advantage. Countries have comparative advantages in those goods for which the required factors of production are relatively abundant locally. This is because the profitability of goods is determined by input costs. Goods that require inputs that are locally abundant will be cheaper to produce than those goods that require inputs that are locally scarce.

For example, a country where capital and land are abundant but labor is scarce will have comparative advantage in goods that require lots of capital and land, but little labor—grains, for example. If capital and land are abundant, their prices will be low. As they are the main factors used in the production of grain, the price of grain will also be low—and thus attractive for both local consumption and export. Labor intensive goods on the other hand will be very expensive to produce since labor is scarce and its price is high. Therefore, the country is better off importing those goods.

Theoretical development of the model

The Ricardian model of comparative advantage has trade ultimately motivated by differences in labour productivity using different technologies. Heckscher and Ohlin didn't require production technology to vary between countries, so (in the interests of simplicity) the H-O model has identical production technology everywhere. Ricardo considered a single factor of production (labour) and would not have been able to produce comparative advantage without technological differences between countries (all nations would become autarkic at various stages of development, with no reason to trade with each other). The H-O model removed technology variations but introduced variable capital endowments, recreating endogenously the inter-country variation of labour productivity that Ricardo had imposed exogenously. With international variations in the capital endowment (i.e. infrastructure) and goods requiring different factor proportions, Ricardo's comparative advantage emerges as a profit-maximizing solution of capitalist's choices from within the model's equations. (The decision capital owners are faced with is between investments in differing production technologies: The H-O model assumes capital is privately held.)

The Heckscher-Ohlin theory states that international and interregional differences in production costs occur because of differences in the supply of production factors:

Commodities requiring for their production much of [abundant factors of production] and little of [scarce factors] are exported in exchange for goods that call for factors in the opposite proportions. Thus indirectly, factors in abundant supply are exported and factors in scanty supply are imported (Ohlin, 1933).

These simple statements lead to an important conclusion: under free trade, countries export the products that use their scarce factors intensively and imports the products using their scarce factors intensively.

A country is labor-abundant if it has a higher ration of labor to other factors than does the rest of the world. A product is labor-intensity if labor costs are a greater share of its value than the are of the value of other products. Those goods that require a large amount of the abundant - and thus less costly -factor will have lower production costs, enabling them to be sold for less in international markets.

For example, India, which is relatively well endowed with labor compared to Switzerland, ought to concentrate on producing labor-intensive goods; Switzerland with relatively more capital than labor, should specialize in capital-intensive products. The Heckscher-Ohlin theory explains some trade patterns quite well, but recent trends hint that the industrial countries are becoming more similar in their endowments, suggesting that this theory, which emphasizes international contrasts in endowments, may slowly become less relevant.

PRODUCT LIFE CYCLE THEORY

The product life-cycle theory is an economic theory that was developed by Raymond Vernon in response to the failure of the Heckscher-Ohlin model to explain the observed pattern of international trade. The theory suggests that early in a product's life-cycle all the parts and labor associated with that product come from the area in which it was invented. After the product becomes adopted and used in the world markets, production gradually moves away from the point of origin. In some situations, the product becomes an item that is imported by its original country of invention. A commonly used example of this is the invention, growth and production of the personal computer with respect to the United States.The model applies to labor-saving and capital-using products that (at least at first) cater to high-income groups.

In the new product stage, the product is produced and consumed in the US; no export trade occurs. In the maturing product stage, mass-production techniques are developed and foreign demand (in developed countries) expands; the US now exports the product to other developed countries. In the standardized product stage, production moves to developing countries, which then export the product to developed countries.The model demonstrates dynamic comparative advantage. The country that has the comparative

advantage in the production of the product changes from the innovating (developed) country to the developing countries.

Product life-cycle

In 1966, Raymond Vernon published a model that described internationalisation patterns of organisations. He looked at how U.S. companies developed into multinational corporations (MNCs) at a time when these firms dominated global trade, and per capita income in the U.S. was, by far, the highest of all the developed countries.

Raymond Vernon was part of the team that overlooked the Marshall plan, the US investment plan to rejuvenate Western European economies after the Second World War. He played a central role in the post-world war development of the IMF and GATT organisations. He became a professor at Harvard Business School from 1959 to 1981 and continued his career at the John F. Kennedy School of Government.

The intent of his International Product Life Cycle model (IPLC) was to advance trade theory beyond David Ricardo’s static framework of comparative advantages. In 1817, Ricardo came up with a simple economic experiment to explain the benefits to any country that was engaged in international trade even if it could produce all products at the lowest cost and would seem to have no need to trade with foreign partners. He showed that it was advantageous for a country with an absolute advantage in all product categories to trade and allow its work force to specialise in those categories with the highest added value. Vernon focused on the dynamics of comparative advantage and drew inspiration from the product life cycle to explain how trade patterns change over time.

His IPLC described an internationalisation process wherein a local manufacturer in an advanced country (Vernon regarded the United States of America as the principle source of inventions) begins selling a new, technologically advanced product to high-come consumers in its home market. Production capabilities build locally to stay in close contact with its clientele and to minimize risk and uncertainty. As demand from consumers in other markets rises, production increasingly shifts abroad enabling the firm to maximise economies of scale and to bypass trade barriers. As the product matures and becomes more of a commodity, the number of competitors increases. In the end, the innovator from the advanced nation becomes challenged in its own home market making the advanced nation a net importer of the product. This product is produced either by competitors in lesser developed countries or, if the innovator has developed into a multinational manufacturer, by its foreign based production facilities.

The IPLC international trade cycle consists of three stages:

1. NEW PRODUCTThe IPLC begins when a company in a developed country wants to exploit a technological breakthrough by launching a new, innovative product on its home market. Such a market is more likely to start in a developed nation because more high-income

consumers are able to buy and are willing to experiment with new, expensive products (low price elasticy). Furthermore, easier access to capital markets exists to fund new product development. Production is also more likely to start locally in order to minimize risk and uncertainty: “a location in which communication between the markets and the executives directly concerned with the new product is swift and easy, and in which a wide variety of potential types of input that might be needed by the production units are easily come by”.

Export to other industrial countries may occur at the end of this stage that allows the innovator to increase revenue and to increase the downward descent of the product’s experience curve. Other advanced nations have consumers with similar desires and incomes making exporting the easiest first step in an internationalisation effort. Competition comes from a few local or domestic players that produce their own unique product variations.

2. MATURING PRODUCTExports to markets in advanced countries further increase through time making it economically possible and sometimes politically necessary to start local production. The product’s design and production process becomes increasingly stable. Foreign direct investments (FDI) in production plants drive down unit cost because labour cost and transportation cost decrease. Offshore production facilities are meant to serve local markets that substitute exports from the organisation’s home market. Production still requires high-skilled, high paid employees. Competition from local firms jump start in these non-domestic advanced markets. Export orders will begin to come from countries with lower incomes.

3. STANDARDISED PRODUCTDuring this phase, the principal markets become saturated. The innovator's original

comparative advantage based on functional benefits has eroded. The firm begins to focus on the reduction of process cost rather than the addition of new product features. As a result, the product and its production process become increasingly standardised. This enables further economies of scale and increases the mobility of manufacturing operations. Labour can start to be replaced by capital. “If economies of scale are being fully exploited, the principal difference between any two locations is likely to be labour costs”. To counter price competition and trade barriers or simply to meet local demand, production facilities will relocate to countries with lower incomes. As previously in advanced nations, local competitors will get access to first hand information and can start to copy and sell the product.

The demand of the original product in the domestic country dwindles from the arrival of new technologies, and other established markets will have become increasingly price-sensitive. Whatever market is left becomes shared between competitors who are predominately foreign. A MNC will internally maximize “offshore” production to low-wage countries since it can move capital and technology around, but not labour. As a result, the domestic market will have to import relatively capital intensive products from low income countries. The machines that operate these plants often remain in the country where the technology was first invented.

 ADVANTAGES:

The model helps organisations that are beginning their international expansion or are carrying products that initially require experimentation to understand how the competitive playground changes over time and how their internal workings need to be refitted. The model can be used for product planning purposes in international marketing.

New product development in a country does not occur by chance. A country must have a ready market, an able industrial capability and enough capital or labour to make a new product flourish. No two countries exist with identical local market conditions. Countries with high per capita incomes foster newly invented products. Countries with lower per capita incomes will focus on adapting existing products to create lower priced versions.

The IPLC model was widely adopted as the explanation of the ways industries migrated across borders over time, e.g. the textile industry. Furthermore, Vernon was able to explain the logic of an advanced, high income country such as the USA that exports slightly more labour-intensive goods than those that are subject to competition from abroad.

According to Vernon, most managers are “myopic”. Production is only moved outside the home market when a “triggering event” occurs that threatens export such as a new local competitor or new trade tariffs. Managers act when the threat has become greater than the risk in or uncertainty from reallocating operations abroad.

The model’s validity was proved by empirical evidence from the teletransmission equipment industry in the post-war years. The model is best applied to consumer-oriented physical products based on a new technology at a time when functionality supersedes cost considerations and satisfies a universal need.

DISADVANTAGES:

Vernon’s main assumption was that the diffusion process of a new technology occurs slowly enough to generate temporary differences between countries in their access and use of new technologies. By the late 1970’s, he recognised that this assumption was no longer valid. Income differences between advanced nations had dropped significantly, competitors were able to imitate product at much higher speeds than previously envisioned and MNCs had built up an existing global network of production facilities that enabled them to launch products in multiple markets simultaneously. Investments in an existing portfolio of production facilities made it harder to relocate plants.

The model assumed integrated firms that begin producing in one nation, followed by exporting and then building facilities abroad. The business landscape had become much more interrelated since the 1950’s and early 1960’s, less US-centric and created more complex organisational structures and supplier relations. The trade-off between export or foreign direct investments was too simplistic: more entry modes exist.

The model assumed that technology can be captured in capital equipment and standard operating procedures. This assumption underpinned the discussion on labour-intensity, standardization and unit cost.

The model stated that the stages are separate and sequential in order. Vernon’s Harvard Multinational Enterprise Project that took place from 1963 through 1986, was a massive study of global marketing activities at US, European, Japanese and emerging-nation corporations. The study found that companies design strategies around their product technologies. High-technology producers behave differently from firms with less advanced goods. Companies that invested more R&D to improve their products and to refresh their technologies were able to ‘push’ these products back to the new product phase.

The relative simplicity of the model makes it difficult to use as a predictive model that can help anticipate changes. In general, it is difficult to determine the phase of a product in product life cycles. Furthermore, an individual phase reflects the outcome of numerous factors that facilitate or hamper a product’s rate of sales making it difficult to see what is happening ’underwater’.

The relation between the organisation and the country level was not well structured. Vernon emphasized the country level. Furthermore, he used the product side of the product life cycle, not the consumer side, thereby stressing the supply side. Selling ‘older’ products to a lesser developed market does not work if

transportation costs for imports is low and information is accessible globally through the Internet and satellite TV.

Foreign markets are not just composed of average income consumers, but contain multiple segments. The research did not consider the emergence of global consumer segments.

OPPORTUNITY COST THEORY:

Opportunity cost is the value of what is foregone in order to have something else. This value is unique for each individual. You may, for instance, forgo ice cream in order to have an extra helping of mashed potatoes. For you, the mashed potatoes have a greater value than dessert. But you can always change your mind in the future because there may be some instances when the mashed potatoes are just not as attractive as the ice cream. The opportunity cost of an individual's decisions, therefore, is determined by his or her needs, wants, time and resources (income).

This is important to the PPF because a country will decide how to best allocate its resources according to its opportunity cost. Therefore, the previous wine/cotton example shows that if the country chooses to produce more wine than cotton, the opportunity cost is equivalent to the cost of giving up the required cotton production.

Let's look at another example to demonstrate how opportunity cost ensures that an individual will buy the least expensive of two similar goods when given the choice. For example, assume that an individual has a choice between two telephone services. If he or she were to buy the most expensive service, that individual may have to reduce the number of times he or she goes to the movies each month. Giving up these opportunities to go to the movies may be a cost that is too high for this person, leading him or her to choose the less expensive service.

The opportunity-cost doctrine, in its original form and in the only form in which its pretensions to being a revolutionary departure from real-cost value theorizing have any basis, treated choice between alternative products (or choice between the utilities derivable from the consumption of alternative products) as the only choice significant for price determination. In this theory the only true cost is foregone product, and relative prices are held to be determined solely by preferences between products and by the technical coefficients of production. In real-cost value theorizing, preferences as between products play a role in the determination of values, but so also do preferences between occupations for their own sakes, as activities, pleasurable or painful, and because of the modes and locations of life necessarily associated with them, and also preferences between employment and (voluntary) non-employment of the factors, and even between existence and non-existence of the factors. In the comparative-cost doctrine, where the problem of trade policy is dealt with from the point of view of under what foreign-trade policy a unit of a given commodity will be procured at the minimum real cost, the

problem of choice between alternative products is abstracted from, but free scope is left for consideration of all the other relevant alternatives between which choice must be made.

The opportunity-cost theory was first applied to the problem of gain or loss from foreign trade as a substitute for the doctrine of comparative real cost by Haberler,5 who claimed for it that it was adequate for the purpose and had the advantage over the doctrine of comparative costs that the use of the factors in variable proportions presented no difficulties for itThe theory is presented in chart terms of so-called indifference curves. Any point on the curve AB represents by its

distance from the horizontal axis the maximum amount of copper and by its distance from the vertical axis the maximum amount of wheat which can simultaneously be produced by the country in question with its existing stocks of the productive factors. The slope of the tangent to the AB curve at any point represents the alternative product cost of copper in terms of wheat, or the number of units copper which must be sacrificed to obtain an additional unit of wheat. In the absence of foreign trade, the relative exchange values of the two commodities must correspond to their alternative product costs, so that, e.g., if at the margin two units of copper must be sacrificed to obtain an additional unit of wheat, then under equilibrium two units of copper must exchange for one unit of wheat. The curve MM′ is supposed to be a “consumption-indifference curve” for this country, tangent at some point, K, to the production curve AB, and points on it represent combinations of copper and wheat which would be equally “valued” by the community. At point K, where the two curves have a common tangent, mm′, the alternative costs and the relative values of the two commodities would correspond. The point K is therefore the equilibrium point, in the absence of foreign trade, and od units of copper and oc units of wheat will be produced and consumed.

The opportunity-cost approach encounters, therefore, on the income side, the same type of difficulty of weighting in the absence of knowledge of the proper weights as does the real-cost approach on the cost side. It remains to be demonstrated that the opportunity-

cost approach avoids the difficulties on the cost side only by avoiding recognition of the considerations which give rise to these difficulties. Let us return to the production or AB curve, and examine its implications. On a true production-indifference curve, any two points would represent the product-combinations resulting from two allocations of productive activity equally attractive to the choosing agent after due consideration had been given to everything associated with such activity except the product outcome. As presented, the AB curve constitutes merely a series of maximum-possible combinations of product when a given stock of productive factors is employed, presumably to its physical maximum. In an actual situation, the actual product-combination would not be on this curve, but would be somewhere below it, if the amounts of the factors, or the extent to which they prefer leisure to employment, were dependent on the rates of remuneration and if the equilibrium rates of remuneration were lower (or higher) than those rates which would induce each factor to render the maximum amount of productive service of which it was physically capable. Even if the extent of employment of the factors was fixed, their allocation as between copper and wheat would be dependent, not only, as is assumed in the diagram and in the opportunity-cost theory, by the relative demands for copper and wheat and the productivity functions of the factors with respect to copper and wheat, but also by the relative preferences of the factors as between employment in copper production and in wheat production. Given the existence of such preferences, then even for a single individual the true production-indifference curve would not be AB, but some other curve lower than AB at some points at least, and higher at none. The opportunity-cost theory thus escapes the difficulties connected with preferences for leisure as compared to employment, preferences as between employments and variability of the supplies of the factor, only by ignoring them.

INVESTMENT THEORIES:

Market imperfection theory:

Caves (1971) expanded Hymer's theory and hypothesized that the ability of firms to differentiate their products - particularly high income consumer goods and services - may be a key ownership advantages of firms leading to foreign production.

The consumers would prefer to similar locally made goods and thus would give the firm some control over the selling price and an advantage over indigenous firms. To support these contentions, Caves noted that companies investing overseas were in industries that typically engaged in heavy product research and marketing effort.

Internalization theory:

Is an extension of the market imperfection theory. By investing in a foreign subsidiary rather than licensing, the company is able to sent the knowledge across borders while maintaining it within the firm, where it presumably yields a better return on the investment made to produce it.

Other theories relate to financial factors. Robert Aliber believes the imperfections in the foreign exchange markets may be responsible for foreign investment. He explained this in terms of the ability of firms from countries with strong currencies to borrow or raise capital in domestic or foreign markets with weak currencies, which, in turn, enabled them to capitalize their expected income streams at different rates of interest.

Structural imperfection in the foreign exchange market allow firms to make foreign exchange gains through the purchase or sales of assets in an undervalued or overvalued currency.

One other financially based theory (portfolio theory) was put by Rugman, Agmon and Lessard. These researchers argued that international operations allow for a diversification of risk and therefore tend to maximize the expected return on investment.

Rugman and Lessard have further argued that the location of the foreign direct investment would be a function of both the firm's perception of the uncertainties involved and the geographical distribution of its existing assets.

Electic theory

The eclectic paradigm is developed by John Dunning seeks to offer a general framework for determining the extent and pattern of both foreign-owned production undertaken by a country's own enterprises and also that of domestic production owned by foreign enterprises.

he eclectic paradigm is a theory in economics and is also known as the OLI-Model.[1][2] It is a further development of the theory of internalization and published by John H. Dunning in 1980.

The theory of internalization itself is based on the transaction cost theory.[3] This theory says that transactions are made within an institution if the transaction costs on the free market are higher than the internal costs. This process is called internalization.

For Dunning, not only the structure of organization is important.He added 3 additional factors to the theory:

Ownership advantages(trademark, production technique, entrepreneurial skills, returns to scale)

Locational advantages (existence of raw materials, low wages, special taxes or tariffs)

Internalisation advantages (advantages by producing through a partnership arrangement such as licensing or a joint venture)

Source: Categories of advantages

Dunning (1981)Ownershipadvantages

Internalisationadvantages

Locationaladvantages

Form of

market entry

 Licensing [1]

 Yes No No

 Export

 Yes Yes No

 FDI

 Yes Yes Yes

Theory

The idea behind the Eclectic Paradigm is to merge several isolated theories of international economics in one approach.Three basic forms of international activities of companies can be distinguished: Export, FDI and Licensing. The so-called OLI-factors are three categories of advantages, namely the ownership advantages, locational advantages and internalisation advantages.A precondition for international activities of a company are the availability of net ownership advantages. These advantages can both be material and immaterial. The term net ownership advantages is used to express the advantages that a company has in foreign and unknown markets.

According to Dunning two different types of FDI can be distinguished. While resource seeking investments are made in order to establish access to basic material like raw materials or other input factors, market seeking investments are made to enter an existing market or establish a new market.A closer distinction is made by Dunning with the terms efficiency seeking investments, strategic seeking investments and support investments.

Trade and FDI patternsfor industries and countries.[5]

Location advantages

Strong Weak

Ownershipadvantages

Strong Exports Outward FDII

Weak Inward FDI Imports

The eclectic paradigm also contrasts a country's resource endowment and geographical position (providing locational advantages) with firms resources (ownership advantages).In the model, countries can be shown to face one of the four outcomes shown in the figure above. In the top, right hand box in the figure above firms possess

competitive advantages, but the home domicile has higher factor and transport costs than foreign locations. he firms therefore make a FDI abroad in order to capture the rents from their advantages.But if the country has locational advantages, strong local firms are more likely to emphasize exporting. The possibilities when the nation has only weak firms, as in most developing countries, leads to the opposite outcomes. These conditions are similar to those suggested by Porter's diamond model of national competitiveness.