Introduction
For many years, the OLI paradigm has been the main analytical framework for determining foreign direct investment (FDI) and the activities of multinational firms. It is a simple, yet profound model that asserts that the composition of multinational enterprises (MNEs) is determined by three sets of interdependent variables which comprise three sub-paradigms. The first involves a competitive advantage that seeks to increase foreign direct investment and entails the ownership’s benefits (Enright, 1991). This sub-paradigm avers that ceteris paribus, that is, the firm is more likely to experience an increase in their foreign investments with a greater competitive advantage. The L is the locational factor or attraction for undertaking the operations to add value to the MNEs (Doremus et al., 2013). This sub-paradigm asserts that the more the natural, immobile endowments can intertwine with the competitive advantages successfully, the more the firm will exploit their O-specific advantages. This essay aims to discuss the three paradigms and how their combination determines the success of foreign direct investment.
Ownership advantage
When the eclectic paradigm was first introduced in 1977, it was based on a common assumption that the ownership or competitive advantage largely relied on the specific capabilities and resources of the home countries of the firms seeking to invest. Also, the eclectic paradigm hinged on the assumption that successful foreign direct investment would only occur when the advantages of doing so were more than the opportunity cost. In the 1970s, a firm’s competitive advantage was mainly measured by its ability to internally produce and organize propriety assets that match the existing market needs. Presently firms are measured by their ability to invest in other countries and integrate their competitive advantages with other firms hence the the emergence of FDI by Dunning (2015), and eventually the importance of multi-nationality.
In explaining the compelling advantages using the resource-based theory, focuses more on the process through which the firm’s specific strengths evolved. It is by nature a dynamic theory and explains a business as an innovation. Thus, a decision maker is expected to explain how a growing firm should optimize its income from the available assets (Daniels, 2012).
The locational sub-paradigm
In the last few years, there has been an increasing interest by economists and industrial geographers in the clustering of many economic activities and the role of currencies affecting the timing, geography, and extent of foreign direct investment (Cushman, 2016). This was based on the idea that a strategic location of the assets of a firm would afford such a firm a competitive advantage.
This sub-paradigm recognizes the location of a firm as being of key importance to the success of MNEs (Dunning, 1995). Furthermore, since the 1930s, many context-specific theories have been explaining the value of strategic location on assets and production for FDI. Such approaches include Vernon's product cycle theory and Knick Broker’s theory of following my lead; they were the earliest attempts at explaining the geographical clustering of FDI. According to Rugman’s theory of risk diversification, MNEs preferred a geographical spread of their FDIs to have all their eggs in one basket (Rugman, 2010).
The internalization aspect
The internalization theory seeks to identify and explain the optimum spatial and organizational dimensions of the existing resources and capabilities of the firms and countries. The sub-paradigm answers whether the warranting the location of value-adding activities or determines whether such activities are undertaken by the firms possessing the needed advantages (Eisenhurt, 2013). In other words, as long as coordination and transaction costs of using nearby external markets in exchanging standard technology, information, and products exceed those incurred by internal hierarchies, then it pays a firm that is engaging in foreign direct investment, rather than getting a license with the foreign producer (Dicken, 1998). The transaction costs associated with external markets are positively correlated with the imperfections of the markets involved. Firms can learn, memorize, and produce tasks that markets cannot emulate. Most cross-border transactions are done to gain new markets, and new capabilities and to reduce the cost of production (Enright, 2010).
Therefore, after carefully putting into consideration the competitive advantage, locational and internalization sub-paradigms and seeing the benefits, a firm can engage in foreign direct investment. The paradigms provide the nature of the asset activity of the firms and their characteristics and objectives. Thus, after firms ascertain that FDI will be cost-efficient and increase production, they become multinational.
Conclusion
In conclusion, the three sub-paradigms do much to uphold their position as the dominant analytical framework for scrutinizing the determinants of foreign production. They help reflect the economic and political features of a country in which firm plans to undertake foreign direct investment. After dynamising the sub-paradigms, and embracing it by including asset augmenting foreign direct investment and multinational enterprises, it proves to be a dominant paradigm that explains and determines the pattern and extent of foreign asset activities of firms wishing to engage in foreign direct investment.
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