Academic journal article Management International Review

The Theory of International Business: The Role of Economic Models

Academic journal article Management International Review

The Theory of International Business: The Role of Economic Models

Article excerpt

1 Introduction

This paper reviews the scope for economic modelling in international business (IB) theory. Economic modelling was commonplace in the 1970s, became unusual in the 1990s, and was controversial by 2000. There are eminent IB scholars today who deny the usefulness of formal economic models in IB.

This is odd. Economic theory addresses existential issues in IB. Why do firms become multinational? Why are some firms multinational and others not? Why did the number and the size of multinationals (MNEs) increase in the 1950s? Why did 'new forms' of MNE emerge in the 1980s and 1990s? Economic theory provides a set of general principles that addresses these issues.

MNEs are clearly economic in terms of the functions they perform, e.g., production, investment and trade. They employ labour, borrow capital and have shareholders who bear business risks. They are not purely economic, of course. Their managers and workers socialise amongst themselves. They are multi-cultural organisations, but they are not the only organisations of this type. The United Nations, the European Union and other inter-governmental organisations are multicultural too. No-one argues that political organisations should be analysed without reference to politics, so why should MNEs be analysed without reference to economics? MNEs may well be multicultural, but that is not their defining characteristic.

Economic analysis has been crowded out of leading IB journals by studies of cross-cultural organisation. These studies examine issues that are not specific to MNEs; they do not explain why MNEs exist, which markets they serve and where they produce. They typically ignore the fact that MNEs are profit-driven, subject to competitive pressures, and must be efficient in order to survive.

Two main factors explain the shift away from economics: economic theory is perceived as highly technical and of little practical relevance, while business strategy is seen as offering a more relevant non-technical substitute.

Critics of economics claim that economic theory has become a mere collection of mathematical models whose assumptions are patently absurd. Mathematics is employed, it is said, not for its practical utility, but to create a pseudo-scientific image and to confer spurious authority. Excessive reliance on mathematics, the critics claim, renders economic theory unintelligible to students and irrelevant to practising managers.

Distaste for economics in general, and mathematics in particular, has led to low citations of economic papers. Some journal editors avoid publishing economics papers because impact factors, and hence rankings, may be lowered; this in turn discourages economic research in IB.

The 'other side of the coin' is the rise of business strategy. It is widely believed that the most important aspects of economic theory have been incorporated into theories of business strategy. There is an element of truth in this. Porter's (1980) seminal work on Competitive Strategy took the basic principles of industrial organisation theory and presented them, not from the standpoint of government regulation, but from a boardroom perspective. There is a problem, however. Porter over-simplified the economic theory of industrial organisation. He dropped the industry perspective, which was fundamental to the theory, and replaced it with the firm perspective. But he failed to alert his readers to what he had done. He coined new terms, such as 'value chain', for existing concepts, such multi-stage production and (more controversially) substituted 'competitive advantage' for monopoly power. By inventing new jargon, and failing to acknowledge some of his sources, Porter cut off his readers from the intellectual tradition on which he himself relied.

In the 1980s a new generation of scholars, teaching strategy in business schools, began to theorise using Porter's concepts, unaware that his over-simplified framework was inadequate for rigorous theory development. …

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