Question

How is Intra-firm trade different from Intra-industry trade? Why might US firms be interested in investing abroad, setting up affiliates, producing parts and components of their products, and import from their own affiliates? Wouldn't it be easier to allow a foreign firm to produce the components and export those to the US? Provide your answer in light of John Dunning's OLI theory. Clarify your answer by using the example of the American Apparel manufacturers who get their garments made abroad in their affiliates and then sew their own labels and sell those finished garments back in the home market.

Answer 1

1. Inter-industry trade is a trade of products that belong to different industries. ... Countries usually engage in inter-industry trade according to their competitive advantages. Intra-industry trade, on the other hand, is a trade of products that belong to the same industry.

An eclectic paradigm, also known as the ownership, location, internalization (OLI) model or OLI framework, is a three-tiered evaluation framework that companies can follow when attempting to determine if it is beneficial to pursue foreign direct investment (FDI). This paradigm assumes that institutions will avoid transactions in the open market if the cost of completing the same actions internally, or in-house, carries a lower price. It is based on internalization theory and was first expounded upon in 1979 by the scholar John H. Dunning.

US firms might be interested in investing abroad, setting up affiliates, producing parts and components of their products, and import from their own affiliates because of the follwing advantages.

The first consideration, ownership advantages, include proprietary information and various ownership rights of a company. These may consist of branding, copyright, trademark or patent rights, plus the use and management of internally-available skills. Ownership advantages are typically considered to be intangible. They include that which gives a competitive advantage, such as a reputation for reliability.

Location advantage is the second necessary good. Companies must assess whether there is a comparative advantage to performing specific functions within a particular nation. Often fixed in nature, these considerations apply to the availability and costs of resources, when functioning in one location compared to another. Location advantage can refer to natural or created resources, but either way, they are generally immobile, requiring a partnership with a foreign investor in that location to be utilized to full advantage.

Finally, internalization advantages, signal when it is better for an organization to produce a particular product in-house, versus contracting with a third-party. At times, it may be more cost-effective for an organization to operate from a different market location while they keep doing the work in-house. If the business decides to outsource the production, it may require negotiating partnerships with local producers. However, taking an outsourcing route only makes financial sense if the contracting company can meet the organization’s needs and quality standards at a lower cost. Perhaps the foreign company can also offer a greater degree of local market knowledge, or even more skilled employees who can make a better product.

American Apparel manufacturers can get their garments made abroad in their affiliates and then sew their own labels and sell those finished garments back in the home market. This gives an advantages to the firm. Labour is cheaper in foreign countries.Using cheap labour and raw materials available in third world countries, an MNC can produce goods at the lowest possible prices. The competition with domestic firms would not be that much. So this model works best in terms of FDI route.