Intra-industry foreign direct investment: Its rationale and trade effects

Intra-lndustry Foreign Direct Investment:

Its Rationale and Trade Effects

By

George Norman and John H. Dunning

Contents: I. Introduction. - 1I. A Taxonomy of International Economic Involve- ment. - III. Intra-lndustry Production (IIFDI). - IV. Some Empirical Comments. - V. Conclusions.

I. Introduction

A longside the growth of intra-industry trade (IIT) between nations there has been a parallel growth in explanations of such trade 1. It is now recognised that IIT cannot be dismissed as merely an aggregation

problem resulting from the inability adequately to delineate an industry. Rather, there are real economic phenomena underlying such trade. These bring consistency to the predicted patterns of trade and require that received trade theory based, for example, upon the H-O-S model should be extended and modified.

It has also been demonstrated that the HoO-S model is incapable of explaining many aspects of international economic involvement that lead to foreign direct investment (FDI) and contractual resource flows, e.g. licensing agreements and management contracts between nations. Theories of FDI have been advanced that are couched in terms of comparative advantage and relative factor endowments [Kojima, 1978], but these tend to be narrow in scope. More satisfactory are the explanations of the perceived behaviour of firms operating in an international economic environment which use an industrial organisation/market failure approach, as recently summarised by Buckley [1983] and Casson [1984].

What is now clear is that intra-industry economic involvement between nations need not be confined solely to IIT. It is perfectly possible that the preferred form of such involvement might take the form of intra-industry production, i.e. production financed by intra-industry foreign direct investment (IIFDI). In place of, or in addition to externalised cross-hauling of final goods in a particular industry, there may be internalised cross-flows of intermediate products in that industry. Indeed, we shall argue that IIFDI is of increasing importance.

See Tharakan [1981]for a recent survey of the literature on IIZ

intra-Industry Foreign Direct Investment 523

The objectives of this paper are first to place IIFDI in context. Secondly, the rationale behind this form of international economic involvement is compared with that which would lead to liT or to FDI, in order to identify elements that are common to each.

Some suggestive empirical evidence will be examined in the light of our theoretical discussion. It must be emphasised, however, that this paper is essentially conceptual. Extensive empirical testing will have to wait a much more disaggregated data set than is currently available on FDI or international production.

II. A Taxonomy of International Economic Involvement

In order to place IIFDI in context we first need a simple taxonomy of different types of international economic involvement. Such a taxonomy is presented in Table 1.

1. I n t e r - I n d u s t r y Flows t h r o u g h E x t e r n a l S p o t M a r k e t s (Cell A)

Where involvement is inter-industry and firms use purely external markets we have a neoclassical situation in which trade is restricted to commodities and is based on some variant of the factor endowments approach. With perfect markets the H-O-S model is appropriate, while neo-technology and related theories are more applicable where some element of market failure exists.

2. I n t e r - I n d u s t r y Flows t h r o u g h I n t e r n a l M a r k e t s (Cell C)

At the opposite extreme we have a situation in which firms use purely internal markets (hierarchies); here use may be made of the received theories of FDI. It is suggested that such investment takes place when three conditions are satisfied1:

- The firm must have some specific advantages (often termed ownership advantages) in operating in particular foreign markets that allow it to compete in those markets vis-a-vis other, and in particular indigenous firms.

- The firm believes that these ownership advantages can be best exploited internally rather than transacted directly through spot markets or offered to other firms by means of non-equity arrangements, e.g. licensing agreements or management contracts.

- There are locational attractions of a foreign as compared to domestic production base in the manufacture of all or part of the product(s) of the firm.

For a more detailed discussion of this eclectic approach see Dunning [1981a].

524 George Norman and 3ohn H. Dunning

Table 1 - A Taxonomy o[ Forms o[ International Economic Involvement

Industrial Composition of Goods and Factor

Markets Used Flows by the Firm Inter- Intra-

Industry Industry

External (Spot)

Contract

Internal (Hierarchies)

A Arm's length transactions No cross-hauling

H-O-S Neo Technology Neo Factor

B Contract transactions No cross-hauling (e.g. of similar technologies) Licensing, Management Contracts

Sub-contracting

C Internalised transactions FDI

General theories Intra-firm of FDI trade

D Cross-hauling of products classified to the same industry

Trading Mixture of oligopo- H-O~S, Linder, lies Grubel & Lloyd,

etc. theories

E Cross-hauling of similar or identical assets/products Cross-licensing Cross sub-contracting

F Cross-hauling of FDI Economies of synergy, vertical and horizontal integration

MNE Oligopolies lntra-firm trade

See theories of Buckley & Casson, Dunning, Caves, etc.

Ownership advantages may vary according to the characteristics of the industry or country of origin of the foreign direct investor, or to those of the firm per se. Industry characteristics include the nature of the production technology and are fairly self-evident. Firm specific characteristics may relate to the firm's size, its product strategy and to its possession of a particular technology or brand name. Country-specific advantages relate to particular factor endowments required for the generation of the ownership advantages; for example labour-scarce countries are likely to generate labour-saving innovations, and materials-scarce countries material-saving innovations.

The decision by the firm to exploit its ownership advantages through purely internal markets is determined by the extent to which it is feasible for it to

Intra-Industry Foreign Direct Investment 525

enter into an enforceable and controllable licensing agreement or management contract that generates a capitalised stream of income which is perceived to represent at least the true worth of the advantage being marketed. Licensing, for example, is less likely to be the preferred route whenever it is difficult

- to find a potential licensee, or

- to formulate a legally binding agreement between licensor and licensee, or

- for the licensor to control the quality of product produced by the licensee 1.

The choice between a foreign and domestic production base is determined in part by the geographical distribution of immobile factor endowments. Alternatively, or in addition the choice may be determined within a horizontally integrated firm by the trade-off between the economies of scale of concentrated production, and transport, tariff and other barriers to the international movement of goods.

There is, therefore, no simple method for judging whether FDI is trade creating or trade inhibiting. What is, however, the case is that the nature of inter-country flows of goods will be changed by inter-country flows of investment. Inter-firm trade is increasingly likely to be replaced by intra-firm trade, particularly in cases where investment flows are a consequence of internalising vertically related production processes or are intended to rationalise horizontally related processes.

3. I n t e r - I n d u s t r y Flows t h r o u g h C o n t r a c t Marke t s (Cell B)

Returning to the taxonomy of Table 1, inter-industry economic involvement in which firms use contract markets (a mix of internal and external markets) arises in cases in which firms have ownership advantages of the types discussed above but decide that these are best exploited through various contractual arrangements. There is an immediate presumption, therefore, that spot or external markets are imperfect.

Contract transactions are more likely to occur when the assets being transferred take a codified form [Teece, 1983], and where the licensor or contractor feels that he can both appropriate the full economic rent on his assets and write an enforceable contract that provides him with adequate safeguards. Alternatively, contracts may replace external market transactions when there is some market failure in the goods being traded, such as that caused by uninsurable risk.

1 For a more extensive discussion of these arguments see Casson [1982].

526 George Norman and John H. Dunning

4. In t ra - Indus t ry Flows through External Spot Markets (Cell D)

Intra-industry economic relations in which firms use purely external spot markets are the most commonly perceived form of IIT. Such trade will take place for a number of reasons each of which is related to the types of good being traded. Four broad types of good can be distinguished':

a) Type I Goods: Complementary in Consumption. IIT in Type I goods arises because intermediate goods at various stages of production are classified to the same industry, and there are gains to be derived from the specialisation and concentration of production of such goods, leading to trade between plants at the various production stages.

The choice of location and trade flows in Type I goods will be determined in part by relative factor endowments, i.e. by H-O-S or neo-technology trade theories [Casson, 1979, esp. Ch. 4] and in part by the relative advantages of plant specialisation and scale economies [Krugman, 1981]. In addition, such trade will occur whenever dual sourcing is believed to reduce the risk of disruption that may occur even in spot markets.

b) Type lI Goods: Substitutes in Production but not in Consumption. Type II goods exist in cases where firms in the appropriate industries produce a range or group of products each of which is classified to those industries. These goods exhibit a high degree of substitutability in production. They are usually produced from a common production base. They are, however, much less substitutable in consumption.

As Krugman [1981] has indicated, IIT in Type II goods will arise because of intra-industry specialisation by countries on sub-sets of each of the industry product groups, in contrast to the inter-industry specialisation suggested by traditional trade theory. Intra-industry specialisation in Type II goods is based upon economies of scale and the gains, e.g. to long production runs, from restricting production of each plant (or firm) to a narrow range of goods [Balassa, 1974].

c) Type III Goods: Substitutes in Consumption but not in Production. Type III goods satisfy particular consumer wants but are produced using different technologies and other factors of production. Examples include wooden and plastic furniture, and leather and rubber footwear. An essential feature of Type III goods is that they must possess some characteristic that differentiates them from other Type III goods in the eyes of the consumer, and this differentiation must be an inevitable consequence of the factors of production embodied in each good. Given these conditions, IIT in Type III goods may be explained by the H-O-S model, relating as it does to differential factor endowments between countries.

' See Willmore [1979] for a similar classification of goods.

Intra-lndustry Foreign Direct Investment 527

d) Type IV Goods: Substitutes in Production and Consumption. Type IV goods are goods that are differentiated in the conventional sense - through packaging, style, brand name and so on. However, IIT in identical products can take place so long as market structure exhibits a significant degree of oligopoly 1.

IIT in Type IV goods is, perhaps, the form of IIT that most readily comes to mind. Reasons for such trade and conditions under which it will take place have been advanced by a number of researchers 2. In particular, the work of Brander (and that of Greenhut and Greenhut [1975] and Norman [1983]) suggests that IIT emerges in an oligopolistic world in which each producer is aware of his rivals and makes some assumption about their expected reactions to a change in price or quantity supplied to the market. It also indicates that oligopolists are more likely to accept market invasion rather than adopt alternative strategies, such as entry-deterring limit pricing, the higher the maximum price consumers are willing to pay relative to marginal production costs, and the lower are transport and other barriers to trade a.

5. I n t r a - I n d u s t r y Trade Flows t h r o u g h C o n t r a c t Marke t s (Cell E)

All that has been written with respect to inter-industry trade flows through contract markets (Section II.3.) equally applies to IIT through such markets, particularly in the case of Type I goods. For other goods there may not be as much sub-contracting per se, but there are benefits to cross-licensing particularly where the asset being licensed is codifiable e.g. as in the chemical and motor vehicle industries.

The resulting asset flows reflect the geographical spread of ownership advantages that are best exploited by non-equity foreign involvement because of the location of immobile assets. In this respect too, there is a parallel with inter-industry contractual transactions.

6. I n t r a - I n d u s t r y Trade Flows t h r o u g h I n t e r n a l Marke t s (Cell F)

There is nothing inconsistent in the proposition that IIT may take place between firms under common ownership and control, e.g. between affiliates of MNEs. The analysis of Section II.4. carries through to this case with little

See Brander [1981]. Models developed in a similar context by Greenhut and Greenhut [1975], and Norman [1983] carry the same implication of cross-hauling of identical or near-identical goods

2 The seminal work of Linder [1961] has been followed up by, for example, Gray [1973[, Barker [1977], Grubel and Lloyd [1975].

a This may explain to some extent why empirical work has been ambivalent on the effects of product differentiation on IIT. Less product differentiation is necessary to generate lIT, the lower are marginal production costs and transfer costs.


amendment. In fact, once allowance is made for the existence of the MNE, stronger reasons may be advanced as to why IIT in the various goods types identified above may take place.

In developing these ideas, we shall initially assume the FDI flows are one-way, i.e. that a country which is a recipient of FDI in a particular industry is not also a source of such FDI. The effects of relaxing this assumption, in which case we have IIFDI, will be considered in Section IIL

Consider Type I goods. In Section II.2. we noted that MNEs are likely to emerge in response to the economies of vertical integration. It is tempting to argue that there will be more IIT in Type I goods the more multinational are the enterprises involved in the production of such goods.

First, since markets are rendered less uncertain by their internalisation, additional trade will result. Secondly, it has been argued that the MNE has the incentive to introduce the type of intermediate products and develop the kind of technologies that allow advantage to be taken of differences in relative factor prices and relative factor endowments between countries at various stages of economic development [Fr6bel et al., 1980].

A similar argument applies to IIT in Type II goods when the firms involved in such trade are multinational in scope. Again it might be expected that the more multinational are the enterprises involved in the production of T~pe II goods the stronger the element of central control and the more IIT in such goods we are likely to perceive.

The MNE producing Type III goods have a number of advantages relative to independent producers of each Type III substitute. First, there will be economies in market research and marketing of a diversified range of products satisfying a common consumer desire. Secondly, inventory control will be easier to achieve and inventory levels of each product variant are likely to be lower than would be necessary for the independent producers. General information flows to the MNE are likely to be of a higher quality than those available to the specialised independent producers. Finally, the MNE offers particular attractions to the potential investor, and so is at an advantage in dealings with the capital market. Holding a diversified portfolio offers the potential investor some reduction in risk, perhaps measured by the variance of returns on asset holdings. In "real world" capital markets, however, portfolio diversification imposes transactions costs - in the form of commis- sion payments and search costs - on the potential investor. These transactions costs can be expected to be lower if the investment is undertaken in a diversified MNE.

This discussion implies, of course, that an increased degree of MNE involvement in the production of Type III goods will give rise to more IIT in such goods. Abstracting from the aggregation problem, the MNE can be expected to be trade creating by using FDI as an export platform and, perhaps, as a means of exploiting a natural resource base.

Intra-lndustry Foreign Direct Investment 529

The impact of the MNE on liT in "I~e IV goods is more awkward to unravel. Recall that we are assuming the FDI is one-way. Even with this simplification, however, the impact of international production on trade flows differs according to the motives for investing abroad. The major advantages of the MNE in supplying Type IV goods are likely to lie in some combination of brand image, the ability to differentiate its goods technologically, and its success in maintaining R & D effort and marketing expertise. The market structure in which liT is conducted may vary from that faced by innovatory oligopolists, e.g. where the ownership advantages of the MNE take the form of new products and/or production techniques, to being that of mature oligopolies or monopolistic competition where the advantages are likely to be more based on brand image, production or marketing efficiency and synergistic economies.

Consider first a monopolistic market structure, or one containing one or a few leading firms and a larger number of smaller imitators. There is some suggestion that the greater the degree of monopoly power in a particular market the narrower the range of product variants that will be supplied to that market [Lancaster, 1979]. If, in addition, there are benefits to rationalising subsets of the product variants into separate plants, and if particular subsets of products are more suited to the needs of consumers in particular markets, then the MNE will be trade inhibiting through import substitution. By contrast, if there are economies of scale and rationalisation but all product variants can be sold in all markets the MNE will be trade creating through export platform FDI.

There is, in fact, some reason to believe that the latter effect will be the more prevalent. As has been observed, the MNE with strong market power is likely to produce fewer product variants than would a series of competitive oligopolists: there will be a movement towards a world good. It follows that each product variant will be aimed at a wider range of consumers across a number of countries.

If economies of scale are weak or transport and tariff barriers are high, the MNE will have a neutral effect on trade. FDI is likely to take place precisely because locational considerations suggest that foreign markets are more profitably served from foreign production sites.

Next, consider the case in which the potential MNE finds itself in a more competitive oligopolistic environment. FDI may take place for the reasons discussed above, but may also act as a form of oligopolistic defence [Knicker- bocker, 1973]. It has been shown [Casson, Norman, 1983] that this type of foreign production is more likely to arise when fixed costs of production are low, the potential market size is large, and there are strong locational advantages in favour of a foreign production base.

In isolation, each MNE might prefer to service its foreign markets by exporting. The loss of profit and market share consequent upon its rivals


choosing to locate abroad are sufficiently great, however, as to cause the MNE itself to choose foreign production - an example of the Prisoner's Dilemma [Luce, Raiffa, 1957]. Clearly, such FDI is trade inhibiting at least in the short and medium run.

HI. lntra-Industry Production (IIFDI) (Cell F)

IIFDI is defined to exist when a particular country is both a source and recipient of FDI in a particular industrial sector. What few data there are [see Dunning, 1981b] indicate that this form of international economic involvement is increasing in importance and appears to be following a pattern similar to that of commodity trade.

For IIFDI to take place at all in a particular industrial sector it is, of course, necessary that FDI in the industry be sourced from a number of different countries. This implies that the ownership advantages accruing to firms in the industry are neither likely to be country specific - e.g. based on access to a particular specialised and localised resource or to a particular market - nor of a kind that gives any one MNE exclusive control of the industry. Rather they are likely to be product or firm specific, and of a kind that may be enjoyed by several MNEs.

The forces underlying IIFDI are best examined using the commodity taxonomy presented above. IIFDI in Type I goods implies that the advantages of vertical integration apply equally whether such integration is forwards or backwards. This is unlikely to be the case in the earlier stages of a multi-stage production process: Dunning [1981b, p. 431] noted the tendency towards "externalising or indigenising the production of primary products". In addition, with some notable exceptions, e.g. in the case of oil, the countries that are the major sources of raw materials are unlikely to be the major sources of FDI.

By contrast, there is evidence to suggest that the advantages of integrating intermediate and final product markets in high technology or branded goods continue to increase [Helleiner, Lavergne, 1979]. Whether IIFDI will emerge in such an industry will be determined by:

- the relative gains and costs of forward and backward integration, and

- the extent to which each stage in the production process offers benefits from concentration, e.g. through plant economies of scale.

As an example, consider the simple three-country example illustrated in part I of the accompanying Figure. There are assumed to be three intermediate products to which there are "strong" economies of scale and for each of which transfer costs are "low". Country C is the sole market for the final product and factors are assumed to be such that the final assembly stage is located in Country C.

lntra-lndustry Foreign Direct Investment 531

Except in conditions where the advantages of forward integration into the final assembly stage are as great as those of backward integration from this stage there will be no IIFDI. The more likely situation would appear to be that backward integration (at all but the final retail stage) offers the greater advantages, particularly if the intermediate component manufacture is highly concentrated.

Now consider the case in which more than one country is a market for the final product (see part II of the Figure). If there are significant economies of scale in the final assembly stage relative to total market size, and/or if transfer costs on the final product are low relative to value added in production, then it is less likely that IIFDI will emerge. By contrast, if minimum efficient scale in final product manufacture is small relative to market size in our three economies, or if there are significant transfer costs on the movements of the final product, IIFDI is more likely. In other words, the more dispersed the production of the final product and the more concentrated the production of the intermediate products, the more likely is it that we shall find IIFDI in that industry'.

Location of Production and Flows o[ Goods and FDI among Countries A, B and C, ~ o Hypothetical Constellations I. ]L

A B A B

@ ,~ ~ ( '2)' ~ commodity flow

--P,~ ftow~ of FDI

IIFDI in Type II goods is a natural consequence of the forces that lead to IIT in such goods, and those that lead to FDI being sourced from a number of countries. The more concentrated (by country) is the ownership of enterprises in Type II industries, the less likely is it that we shall find IIFDI in such industries. Put another way, if we can find evidence of increased multinationality across a number o[ countries in Type II industries this would be highly suggestive evidence that IIFDI is also increasing.

Recall that we are assuming the final production stage to be eharacterised by a multinational oligopoly, rather than dominated by MNEs sourced from a single country.

Weltwiflschaftliches Archiv Bd. CXX. 9

532 George N o r m a n a n d l o h n H. D u n n i n g

Similar comments apply to Type III goods. Indeed, it is to be expected that the advantages conferred upon an MNE in this type of industry will not be country specific and so will lead to IIFDI: our discussion of the motives for FDI on the part of firms producing Type III goods implies that the relevant ownership advantages are firm rather than country specific.

Some of the common themes emerging from the above discussion recur when we examine the forces that will lead to intra-industry production in Type IV goods. Industry structure will be typically that of a multinational oligopoly, and ownership advantages will relate to firm-specific factors such as product differentiation, brand image and marketing expertise. In such industries, FDI is likely to arise as an oligopolistic defence (or anticipation) of rivals' actions that undermine the profitability/feasibility of market servicing by exports. Market conditions that lead to cross-hauling of capital rather than commodities can be identified using a model such as that developed by Norman [1983].

Putting the Norman model in an international context, if firms producing Type IV goods have a common production location (i.e. locate in the same country) the pattern of delivered prices across their international markets will exhibit a relatively small degree of freight absorption. Alternatively, if the producers are dispersed across the various markets each firm will be forced to absorb a much greater proportion of transfer costs if it is to compete in the more distant markets. It follows that the weaker are the economies of scale and/or the lower are the additional costs of setting up a foreign operation, and the greater are the transfer costs between markets (relative to marginal production costs) the greater will be the incentive to switch from exporting to foreign production ~.

The model underl ing this discussion assumes a commonality in consumer incomes and tastes. In addition, there is the assumption that consumers can easily obtain information regarding substitute commodities available in the market place. It follows, therefore, that IIFDI in Type IV goods, as with liT in such goods, is most likely to occur between economies at similar levels of economic development.

Barriers to entry in Type IV industries will be lower - in large markets - as these will better sustain a wider range of product

differentiates, - in markets characterised by a sophisticated economic and social environ-

ment - because information structures will be more efficient for both consumers and producers, and indigenous firms will be better able to break down technological and other monopolistic advantages of foreign firms.

i Similar models in the spatial price literature can be applied to generate the same conclusions [e.g. Greenhut, Greenhut, 1975]. Brander [1981] adopts a theoretical framework that has much in common with that used by Greenhut and Greenhut and notes that his analysis could apply to IlFDI.


Where these conditions are met, it will be more difficult for MNEs from a single country to control entry of firms from other countries producing substitute products and embodying similar technologies. As a result, oligopolistic uncertainty will increase as will the incentive to serve foreign markets by FDI [Casson, Norman, 1983].

Market size and growth are particularly important determinants of IIT and IIFDI. There is, for example, a discernible tendency for U.K. banks to invest in the U.S. primarily by acquisition of indigenous banks. One motive suggested for this development relates to discussions currently taking place in the U.S. on proposals to relax restrictions on U.S. banks with respect to inter-state banking. Such a relaxation would confer a particularly important country- specific advantage on U.S. banks - viz. market size. The only defence on the part of non-U.S, banks would be to enter the U.S. market, something they may be able to do on the basis of their existing ownership advantages e.g. capital backing, expertise and market contacts.

Initially at least, IIFDI in 3~r IV goods is likely to be trade inhibiting rather than trade creating: trade is more likely where economies of scale are "strong" and transfer costs "low", while FDI is more likely where economies of scale are "weak" (relative to market size) and transfer costs "high". However, the longer-term effects on trade are unclear, since the foreign plants may be used to serve purely local markets or may be oriented to foreign markets.

To summarise this discussion, IIFDI is likely to be greater the more the ownership advantages of the MNE are firm rather than country specific. For Type I, II and III goods IIFDI is a natural extension of the increasing degree of multinationality of enterprises based in non-U.S, locations. Such increased multinationality is to be expected, first as a consequence of technology transfer flowing from U.S. FDI to the developed countries, and secondly as enterprises in these latter countries gain experience of operating across international boundaries, e.g. as a result of the formation of the EEC and the reduction in barriers to capital transfers between member states of the EEC.

It should be noted that this form of IIFDI is likely to be more trade creating than trade inhibiting. In other words, while we have argued that IIFDI has lagged liT, it is to be expected that IIT, at least in Type I-III goods, will increase in response to increased IIFDI. What is equally true, of course, is that an increasing proportion of this trade is likely to be intra-firm trade [Dunning, Pearce, 1981].

For Type IV industries trade and FDI are more clearly substitutes, at least at the early stages. That market structure is characterised by multinational oligopoly is a natural outcome of increased market size and sophistication, standardisation of technology, and attempts to protect domestic markets by tariff and other barriers to imports. The dynamics of any or all of these factors is to reduce the barriers to entry of rival, indigenous firms. As these firms gain

9*


experience of operating internationally, IIFDI can be expected to follow and increase in importance.

IV. Some Empirical Comments

Unfortunately, there are very few data available that will allow an analysis of the extent of and reasons for IIFDI. In addition, these data are, in general, at too high a level of aggregation to allow meaningful empirical testing of the propositions underlying the discussion above.

Data reported by Buckley and Casson [1976] (derived from Vaupel, Curhan, 1974) and Stopford and Dunning [1983] suggest that while the major initial source of multinational activity since the 1940s has been the United States, other countries, particularly European nations and Japan, are under- taking a much greater proportion of current FDI. In addition, the majority of such FDI is being channelled into developed countries.

Graham [1975] compared the industrial distribution of foreign subsidiaries of 187 U.S. companies with subsidiaries in Europe and 88 European firms with subsidiaries in the U.S. He noted that "[the] similarity of the two distributions suggests that large European firms which have made direct investments in the US operate in the same industries as large US firms which have made direct investments in Europe" [Graham, 1975, p. 123].

Dunning [1981b] calculated the intra-industry direct capital stake ratios for each of nine sectors using a ratio that is the direct analogue of the Grubel and Lloyd index of intra-industry trade. These ratios indicate that the composition of inward and outward foreign direct investment has become more similar during the 1970s. While no clear patterns are identifiable from these data - principally as a result of the level of aggregation - Dunning [1981b, p. 434] noted that "the traditional sectors ... generally recorded the lowest ratios ... [and] ... the more technology intensive sectors recorded the most pronounced increases in ratios", a finding that is consistent with the proposition that IIFDI is more likely the more that ownership advantages are firm specific rather than country specific.

More disaggregated indices of lIFDI may also be calculated using data published by Vanpel and Curhan [1974] detailing the number of overseas subsidiaries of 187 U.S. MNEs as of ]anuary 1st, 1968, and 226 non-U.S. MNEs as of January 1st, 1971. These companies are estimated to have accounted for about 70 percent of FDI in manufacturing in 1970.

Following Aquino [1978] the index of IIFDI used is the Grubei and Lloyd index corrected for the effects of trade imbalance. This index is:

(ajO, + bjI 0 -[ a,O~j- bjI,,[ IIFDIij = (aiO . + b,I,)

lntra-Industry Foreign Direct Investment 535

where: O~i = number of subsidiaries in industry i formed overseas by finns based in country j,

I~i = number of subsidiaries in industry i formed in country j by firms not based in country j,

and

= + / 2

b i = i ~ ( O ~ + I 0 / 2 ~ I ~

The resul ts are summar i sed in Table 2 and are cons is ten t wi th D u n n i n g ' s

findings. The index of I IFDI tends to be greates t in t echno logy- in tens ive

industr ies such as chemica l s and al l ied products , eng ineer ing products , and

electr ical and e lec t ron ic products .

Table 2 - lntra-lndustry Foreign Direct Investment"

Industry

Ordnance

Meat Product Dairy Products Canned Foods Grain Mill Products Bakery Products Confectionery Products Beverages Other Food Products Tobacco

Textiles Apparel

Lumber and Wood Furniture

Paper Products Printed Matter

Industrial Chemicals Plastics and Synthetics Drugs Soap and Cosmetics Paints Agricultural Chemicals Other Chemicals Refined Petroleum Other Petroleum Products

U.S.

0.00

0.00 0.70 0.77 0.35 0.00 0.29 0.64 0.66 0.65

0.74 0.00

0.66 0.90

0.74 0.30

0.86 0.77 0.73 0.72 0.76 0.56 0.26 0.84 0.62

U.K. Germany France Japan

0.00 0.75 0.00 0.64

0.92 0.00 0.00 0.00 0.68 0.00 0.00 0.64 0.97 0.00 0.00 0.00 0.92 0.00 0.00 0.00 0.09 0.00 0.00 0.00 0.93 0.00 0.55 0.38 0.68 0.00 0.00 0.00 0.32 0.96 0.17 0.92 0.00 0.00 0.00 0.00

0.76 0.54 0.76 0.37 0.93 0.00 0.72 0.19

0.90 0.00 0.00 0.52 0.63 0.00 0.94 0.00

0.69 0.91 0.39 0.88 0.71 0.72 0.52 0.64

0.93 0.77 0.80 0.11 0.61 0.87 0.39 0.49 0.46 0.63 0.79 0.35 0.53 0.49 0.00 0.00 0.56 0.51 0.00 0.17 0.84 0.43 0.49 0.00 0.72 0.61 0.97 0.59 0.75 0.07 0.76 0.11 0.68 0.73 0.55 0.00

(continued)


(continued)

Industry

Tires Other Rubber Products

Leather Products and Shoes

Glass Products Stone, Clay and Concrete

Iron and Steel Products Non-ferrous Smelting Non-ferrous Products Metal Cans Structural Metal Products Fabricated Wire Products Other Fabricated Metal Engines and Turbines Farm Machinery Construction Machinery Special Industry Machinery . . . . . General Industry Machinery Office Machinery and Computers Other Non-Electrical Machinery .

Electrical Transmission Equipment Electrical Lighting and Wir ing. . . Radio, TV and Appliances Communications Equipment Electric Components Other Electrical Equipment . . . . .

Motor Vehicles and Equipment .. Other Transportation

Precision Goods

Miscellaneous Products

Overall Index of IIFDI

a For definition of the index, see text.

Germany France Japan

0.23 0.87 0.53 0.74 0.38 0.49 0.48 0.61 0.95 0.91

0.89 0.43 0.00 0.00 0.00

0.69 0.20 0.23 0.13 0.27 0.24 0.71 0.63 0.52 0.74

0.45 0.94 0.39 0.97 0.11 0.67 0.89 0.77 0.83 0.83 0.93 0.56 0.29 0.45 0.00 0.82 0.24 0.00 0.00 0.00 0.49 0.74 0.52 0.72 0.46 0.40 0.53 0.89 0.36 0.00 0.82 0.53 0.91 0.74 0.88 0.70 0.35 0.83 0.25 0.44 0.76 0.28 0.00 0.37 0.00 0.23 0.39 0.53 0.00 0.83 0.89 0.44 0.33 0.44 0.77 0.89 0.77 0.99 0.42 0.17 0.76 0.21 0.31 0.00 0.27 0.62 0.39 0 69 0.25 0.77

0.87 0.96 0.31 0.42 0.74 0.68 0.81 0.41 0.61 0.52 0.75 0.95 0.65 0.95 0.45 0.79 0.73 0.25 0.69 0.97 0.24 0.45 0.91 0.88 0.97 0.80 0.97 0.86 0.79 0.83

0.18 0.80 0.66 0.76 0.61 0.63 0.35 0.91 0.90 0.00

0.46 0,30 0.99 0.34 0.00

0,97 0.43 0.34 0.32 0.00

0.64 0.64 0.61 0.56 0.46

Source: Based on the subsidiaries of 187 U.S MNEs (as of January 1st, 1968) and 226 non-U.S. MNEs (as of January 1st, 1971). Derived from data published in Vaupel and Curhan [1974].

Very few countries produce a detailed industrial breakdown of both the outward and inward capital stock. West Germany is one of the exceptions and Table 3 sets out intra-industry capital stake in selected manufacturing and service sectors in 1976 and 1981. There is some suggestion that in technology- and/or information-intensive sectors, and/or those in which competitive or oligopolistic MNE advantages are likely to be firm - rather than country -

lntra-Industry Foreign Direct Investment 537

specific, the (adjusted) IIFDI index is higher than its equivalent in traditional sectors. There is, however, little discernible pattern to the changes in the index over the period 1976 - 1981.

Table 3 - lntra-lndustry Foreign Capital Stake in Selected Manu[acturing and Service Sectors: West Germany, 1976 and 1981

Industry

Manu]acturing Food Tobacco Textiles Clothing Wood-working Paper, Board, Printing etc. Chemical Industry Plastics Mineral Oil Processing . Rubber Leather Industry . . . Fine Ceramics and Glass Earthen and Stoneware. Iron and Steel Products. Foundries

Capital Stake 1976 1981

0.40 0.30 0.91 0.35 0.65 0.69 0.56 0.40 0.62 0.94 0.50 0.61 0.66 0.65 0.66 0.54 0.19 0.18 0.36 0.43 0.40 0.50 0.53 0.55 0.91 0.93 0.89 0.89 0.47 0.31

Industry

M anu[acturing Non-ferrous Metals Drawing, Rolling and Forming Steel, Light Metal Engineering Iron, Tin-ware, Metal Goods. Mechanical Engineering Electrical Engineering Transport Equipment . . . Instrument Engineering

]Services Transport and Communications Building Trade Banking Finance Institutions Insurance Corporations

Capital Stake 1976 1981

0.99 0.51 0.52 0.64 0.87 0.86 0.67 0.55 0.97 0.92 0.88 0.69 0.85 0.65 0.90 0.95

0.81 0.91 0.66 0.37 0.51 0.47 0.90 0.88 0.03 0.68 0.81 0.54

Source: Deutsche Bundesbank [unpubl. data].

V. Conclusions

It should be clear from the above analysis that intra-industry foreign direct investment or production as a form of international economic involvement has a rationale based both on intra-industry trade and inter-industry production.

We have argued that IIFDI is a natural consequence of those economic factors that will lead to liT, these in turn being determined by the nature of the "industry" in which the IIT occurs. In addition, however, IIFDI implies that international transactions are best conducted within hierarchies rather than through (spot) markets, for reasons that can be deduced from received theories of multinational operations.

It may be argued that IIFDI is the final stage in an evolutionary process which begins with inter-industry trade [Dunning, Norman, 1983]. Intra- industry trade or inter-industry production follows, and then intra-industry production based upon firm-specific transaction-cost-economising advantages of multinational oligopolies. Nevertheless, it is to be expected that there will be some feedback from intra-industry production to intra-industry trade.


Many of the hypotheses presented above have a strong empirical content. It is, however, the case that testing of these hypotheses will have to await more disaggregated data than are currently available. What is quite clear, both from theory and such data as are available, is that intrg-industry production can be expected to grow in importance, particularly if left free of government interference. It will then be the case that its natural complement - intra-firm trade - will also grow in importance.

References

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Balassa, Br A., 'q'rade Creation and Trade Diversion in the European Common Market: An Appraisal of the Evidence". The Manchester School, Vol. 42, 1974, pp. 93-135.

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Brander, James A., "Intra Industry Trade in Identical Commodities". Journal of International Economics, Vol. 11, 1981, pp. 1-14.

Bur Peter J~ "New Theories of International Business: Some Unresolved Issues". In: Mark C. Casson (Ed.), The Grozvth of International Business. London 1983, pp. 34-50.

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540 George Norman and John H. Dunning Intra-lndustry Foreign Direct Investment

Zusam m enfa s sung : Intra-industrielle Direktinvestitionen im Ausland: Ihre Grfinde und Auswirkungen auf den Aul]enhandel. - Der Aufsatz zeigt, dag intra-industrielle Direktin- vestitionen oder die daraus finanzierte Produktion im Ausland Formen des internationalen wirtschaftlichen Engagements sind, die ihre Begrfindung sowohl im intra-industriellen Handel als auch in der inter-industriellen Produktion finden. Dies wird an Hand einer Taxonomie aufgezeigt. Es wird argumentiert, dal] intra-industrielle Direktinvestitionen im Ausland eine natfirliche Folge der gleichen Faktoren sind, die zu intra-industriellem Handel ffihren, wobei untemehmensspezifische Vorteile wichtiger sind als die in einem Land begriindeten Vorteile. Intra-industrielle Auslandsinvestitionen bedeuten aul~erdem, dal~ internationale Transaktio- hen am besten in hierarchischer Form und nicht fiber (Kassa-)Markte durchgefiihrt werden, und zwar aus Griinden, die den g/ingigen Theorien fiber multinationale Operationen entnom- men werden k6nnen. Ganz sicher folgt sowohl aus der Theorie als auch aus den verfiigbaren Daterl, dal] die intra-industrielle Produktion wahrscheinlich an Bedeutung gewinnen wird, vor allem dann, wenn keine Eingriffe dutch die Regierungen erfolgen.

R6sum6: Investissement 6tranger direct intra-industriel: sa base raisonn6e et ses effets commerciaux. - L'article d6montre que l'investissement 6tranger direct intra-industriel (IE- DII) ou la production correspondante comme forme d'engagement international 6conomique est soumise ~ des motifs rationnels qui basent sur le commerce intra-industriel (CII) et la production inter-industrielle. Les auteurs arguent que I'IEDII est une cons6quence naturelle des facteurs 6conomiques qui m~nent au CII et qui m~me sont d6termin6s par la nature de ~d'industrie,, dans laquelle le CII se passe. En plus, cependant, I'IEDII implique que les transactions internationales sont conduites le mieux par des hi6rarchies et non par des march6s ~ cause des raisons qui peuvent ~tre d6duites par des th6ories reques des op6rations internationales. I1 apparai't clairement, de la th6orie aussi bien que des donn6es disponibles que probablement la production intra-industrielle gagnera en importance, particuli~rement si elle restera libre de l'intervention gouvernementale.

Resumen: Inversion extranjera directa en la industria: raz6n de su impacto sobre el comercio. - El articulo muestra como la inversi6n extranjera directa intra-industrial o la producci6n como forma de participaci6n econ6mica internacional tiene una raz6n de ser basada en el comercio y en la producci6n intra-industrial. Se propone que la inversi6n extraniera directa es una conscuencia natural de los factores econ6micos que llevan el comercio intra-industrial, los que a su vez estfin determinados por la naturaleza de la industria en el que el comercio tiene lugar. La inversi6n extranjera directa implica adicionalmente sin embargo que las transacciones internacionales se eiecutan meior a trav6s de jerarqufas que a trav6s de mercados por razones que pueden ser derivadas de conocidas teorfas sobre operaciones multinacionales. Es evidente, por medio de la teoria y de las estadfsticas disponibles, que se puede esperar un crecimiento de la producci6n intra-industrial, especial- mente si se le libera de interferencia gubernamental.

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Intra-industry foreign direct investment: Its rationale and trade effects