The eclectic theory

The eclectic theory postulates that three conditions must be satisfied if a firm is to engage in FDI.First, it must have a comparative advantage over other firms arising from the ownership of some intangible assets.These are called ownership advantages, and include the right to a particular technology, monopoly power and size, access to raw materials and access to cheap finance.Second, it must be more beneficial for the firm to use these advantages rather than to sell or lease them.These are the internalization advantages of choice between accomplishing expansion within the firm and achieving the same goal with other firms.Third,it must be more profitable to use these advantages in combination with at least some factor inputs located abroad.If this is not the case, then exports would do the job.These are called location advantages, and pertain to the question as to whether expansion is best accomplished at home or abroad.

Suppose that there is demand for a particular product in which a particular domestic firm has some ownership advantage.What happens (that is, how the firm responds)depends on the internalization and location advantages.So, there are the following possibilities:

● If there are no internalization gains, the firm will license its ownership advantage to another firm, particularly if location factors favor expansion abroad.

● If there are internalization gains and if location factors favor domestic expansion, the firm will expand at home and export.

● If there are internalization gains and if location factors favor foreign expansion, FDI will take place and a multinational firm will emerge.