Cultural sensitivity of the eclectic paradigm, The

cultural sensitivity of the eclectic paradigm, The

Dunning, John H

This paper explores the extent to which the variables of the eclectic paradigm (Dunning, 1995) are affected by home and host country cultures. It is postulated, for example, that asset based ownership advantages (Oa) are created by cultures that are individualistic; governance based ownership advantages (Ot) are more likely to be the strength of integrated, moral and high trust (Casson, 1992) cultures. Modal choices are also a function of Hofstede’s (1980) uncertainty avoidance, power distance and masculinity measures; for example, high trust cultures which are also high in terms of power distance (Shane, 1994 and 1995) show a lower tendency to internalize. Location choices are determined by the cultural distance between the home and host countries perceived by the investing firms, as well as their attitudes to risk and uncertainty. An example of how the culture of the home country may affect the industrial structure of fdi is given by reference to Japanese and US MNE activity in Europe.


It is sometimes remarked that `the Cold War is over and Japan won’ . The renaissance of the market based economy is apparent but, within the capitalist ideology, there are differences in the economic systems and institutions of `the West and the Rest’, the Rest being Japan, South Korea, Hong Kong, Singapore, Taiwan and Malaysia, and also the emerging economies one or more steps behind in the development chain, such as China, Indonesia, Thailand and India. A realignment of superpowers along different ideological, political and sociological vectors coupled with the exponential increase in all kinds of international transactions is compelling scholars to give more attention to the role of culture in determining the ownership and locational patterns of business activity. This is underscored by the fact that much of the world’s growth over the next decade is expected to be accounted for by East Asian and Indian countries.

Globalization, as a process of internationalization, has reached new heights and dimensions as both enterprises and governments, from different countries, become increasingly affected by each other’s behavior and strategies. Some international scholars perceive the actions taken by these two actors as `culture-free’; and their decisions to be guided by pure rationality and self interest. Others see these actions as being governed by a sort of “bounded rationality”, where decisions are made under informational constraints, and where culture is sometimes used as a heuristic for these decisions (Schneider and DeMeyer, 1991). Some commentators even see a “clash of civilizations” in the coming years – where the fundamental source of conflict between nations will not be primarily ideological or economic, but cultural (Huntington, 1993). As Monsen commented more than thirty years ago:

Ideologies of competitive interests are in a very real sense weapons used against each other in national or international groups. While battles are not necessarily won by the most popular ideology – strength being not only a matter of numbers – wars eventually are influenced or won by the ideologies which win most fervently the hearts and minds of men. Thus ideas become weapons. (Monsen, 1963)

The ideological differences between the developed Western nations and the newly developed and developing nations of the East are manifested in a variety of ways. The role of entrepreneurship, business customs, work practices, consumer expectations, organizational structures, attitudes to foreign investment, business/government relations, and the time horizon of decision taking, are just a few of the culturally related factors which affect the competitiveness of a nation. While these factors are not new in the world economy, what is, perhaps, new is the extent to which, and the form in which, different cultures are interacting with each other.

This new awareness is the direct result of the denser integration of the world economy, brought about by the growing mobility of intangible assets and people; and of global product mandates. Through travel and television, consumers in one country are linked to the buying habits of those in another. Firms of developing nations seek foreign technology, and firms of developed nations seek new markets and consumers. Foreign direct investment (fdi) and cross-border alliances, much more than trade, have proven to be mutually beneficial arrangements for some industrialized countries to “catch up”, and for others to “forge ahead”. The share of global production and trade now accounted for by multinational enterprises (MNEs) is now sufficiently large to make them one of the most significant transmitters of ideologies and values across national boundaries. In such a scenario, cultural incompatibility between nations and the inability or unwillingness of firms to take account, let alone resolve inter country cultural differences, may be a severe constraint in advancing competitiveness.

A significant development in the last decade or so has been the emergence of alliance capitalism, a term, coined by several writers, e.g. Best (1990), Gerlach (1992), to describe a situation in which the cross-border activities of firms are becoming increasingly dependent on the cooperative agreements and strategic alliances they form with other firms. As Dunning (1995) elaborates, the institution of hierarchical capitalism, implicitly assumes that the wealth of firms largely resides in the endogenous assets they possess and the way in which these are organized. In hierarchical capitalism, too, firms usually react to any form of market failure – structural or transactional – in one of those main ways, viz take no action, to internalize the market for transactions or to retaliate in a competitive and confrontational manner to their competitors moves. By contrast, alliance capitalism stresses the need of firms to cooperate with each other to protect existing ownership advantages and gain new ones in an age of rapid technological obsolescence and rising fixed costs – a “voice”, rather than an “exit” strategy (Hirschman 1970). The governance structure of these alliances is based on shared goals, mutual trust, commitment and consensus. In such cases, the cultures of the partners in such alliances are highly critical in determining the success or failure of these alliances, and thus, the future competitive advantages of the firms in the industry.


Culture has been defined as an “informal institution” that constrains behavior and structures political, economic and social interaction (North, 1991). It has also been seen as a “determinant of preferences” or “collective subjectivity” (Casson, 1993); the subjectivity being revealed in individual preferences that are not directly measurable, and in the attachment of probabilities. This means that, in economic terms, individuals do optimize, but under culturally perceived constraints.

Culture is a generic term and is made up of a host of interrelated elements. These include family, language and communication, religion, government and politics, education, technology, society, and economic structures and activities. (Baligh, 1994). Although we are presently studying culture as it manifests itself in economic activity (particularly MNE activity), we cannot entirely separate this from its other attributes. The links between the various components of culture gives it an allencompassing perception, and its importance is diminished by relegating it as a catch-phrase for anything. One solution, prescribed by scholars, is to describe the culture in terms of the particular attribute being studied; this for example was done by Myrdal (1970) in describing the culture needed for economic development. It is also the methodology of Hofstede (1980) in his studies of the impact of culture on work related attitudes.

It is worth noting that various attempts at broad categorization of cultures have not yielded very different components, though certain details may differ. For example, Casson’s high tension society is Hofstede’s masculine society; his atomistic versus organic society corresponds to the individualism measure; and his high trust – low trust classification corresponds closely to the power distance measure. Michael Bond’s research, based not on Western social science, but on a list of 40 fundamental values of Chinese people (Bond 1988) also yielded four factors, three of which correlated significantly with Hofstede’s original measures. For example, Bond’s Integration overlaps Hofstede’s Individualism and Power Distance, his Human Heartedness with Hofstede’s Masculinity, and his Moral Discipline with Hofstede’s Power Distance (Franke, Hofstede and Bond, 1991). Lodge and Vogel (1990), too, classify countries along Individualism and Communitarianism, captured by Hofstede’s Individualism measure. Other orientations relevant to the organization of work in different countries are Dependism (as in the work ethic of communist or ex-communist countries) (Tidmarsh, 1993), Extractionism (as in economies with large natural resources such as Latin America), and Manufacturism (in Western economies). (Maruyama, 1991). The last one has been further described as Fordism or Taylorism and is contrasted with Toyotaism -the former signifying bureaucratic control, scientific management principles and extensive division of activities, while the latter is identified with flexibility, mutual trust, involvement of employees in multiple stages of production, and efficiency, often at no extra cost (Weiermair, 1990).

Culture’s Relevance to MNE Activity

The role of culture in understanding MNE activity, particularly its determinants and its effects, can be looked at in the following ways:

a) The effect of culture on a nation’s institutions. At any given moment of time, the institutions of a nation (constitutions, laws, property rights, government) are shaped by the culture in which they are embedded. Over time, of course, culture may, itself, be affected, e.g. by economic development and exposure to the cultures of other nations. In turn, these institutions help shape the culture of the nation by legitimizing certain behavioral patterns, and then rewarding those who comply and punishing those who do not. The kanban, the keiretsu and government-business relationships in Japan are often cited as both the manifestation of and the results of their culture (Davidson, 1988). Similarly, the system of checks and balances in the office of the executive branch of the US government which prevents concentration of power in any one person is believed to be an effect of the Founding Fathers’ distaste with monarchy (Vernon and Spar, 1989). Insofar as these institutions affect the competitive advantages available to the firms of one nation versus the other, they affect international business activity.

b) The effect of (home) culture on MNE activity. MNEs look beyond their home countries to sell their products, source their materials and other inputs, reduce labor costs or to acquire strategic assets and preempt or counteract the actions of competitors. Does national culture affect the propensity of a nation to engage in fdi, and does the culture affect the locational and modal choices? In other words, does culture affect the competitiveness of firms and their perception of transaction costs and market failure. Is one culture likely to prefer fdi than exports as a mode of penetrating foreign markets than another? How far is the response of firms to market failure culture specific? Once investment is undertaken, does its success depend on cultural traits of investors as manifested in their organizational techniques; and the way they adapt to local capabilities and tastes? How does the home country culture of an MNE affect its ability to conclude successful strategic alliances with other firms and enhance or protect its ownership advantages?

An interesting illustration is the difficult issue of U.S.-Japan auto related trade deficit, which is roughly two-thirds of the bilateral trade deficit of the US and keeps widening. While part of the explanation for this deficit is due to artificial entry barriers faced by US firms, part reflects the marketing cultures of Japanese autoproducers. For example, Toyota, which sells two out of every five cars sold in Japan, has a virtual army in its sales force, who sell cars to housewives going door to door. They develop long term, personal relationships with households and people never go to the dealership to buy the car or test drive it. The salespeople bring cars to their homes. Even stocking the U.S. made cars in Japanese dealerships would not change the status quo, as the relationship between the dealer and the customer are a minikeiretsu in themselves – the Japanese way of doing business with those they know and trust.

c) The effect of MNE activity on (host) culture. As Perlmutter (1969) pointed out many years ago, MNEs differ in their propensity to transfer their home practices abroad based on their levels of ethnocentricity, polycentricity or geocentricity. MNEs are likely to have a more pronounced effect on the culture of the countries in which they do business because of the long term and embedded nature of their activities. This cultural transfusion varies across countries and industries. MNEs impact on host country cultures in several ways. For example, they may help create demand where none existed or even raise the standards of demand (Porter, 1990). They may inject a spirit of entrepreneurship and competition among local companies. They may inculcate its labor force with a new attitude towards teamwork. They may help change the relationships between themselves and their suppliers. They may even improve quality standards of production which can result in spill over effects whereby quality of other related products are also improved.

However, MNEs can also misuse their superior competitive strengths in countries which are all too eager to adopt (perceived) culturally superior practices brought in by the agents of modernization. For example, the infant food industry played a large role in changing feeding habits across many developing countries, till malpractices (such as false information coupled with heavy advertising) were exposed and it became mandatory for infant food companies to print scientifically proven information (such as the nutritional superiority of mother’s milk) on each can sold (Mattelart, 1983). It may be argued that a foreign culture most easily spreads to host countries that lack national identity, self reliance, free flow of information, forms of consumer protection and a well established media. The cultures of some home countries are certainly more appealing than others. Moreover, the power of one country to influence another may be enhanced by the attractive “packaging” of their values and beliefs (e.g. by films, television, games, media and popular literature).


Economists have tried to explain the foreign activities of MNEs by offering specific operationally testable variables, some of which are presence of home demand (Vernon, 1966); market power and intangible assets (Hymer, 1960, 1968; Caves, 1971); follow my leader strategy of oligopolistic firms (Knickerbocker, 1973) or national comparative advantage (Kojima, 1990). One of the general paradigms that offer explanations of MNE activity is the eclectic paradigm (Dunning, 1981; 1993; 1995). How have these scholars dealt with the issue of culture? Is it irrelevant to their arguments or is it implicit in them? In this paper we shall chiefly be concerned with examining the cultural sensitivity of the eclectic paradigm, but before we do so, let us briefly examine the cultural elements of these other explanations.

Vernon’s product life cycle theory was an attempt to explain the innovations of firms based on the demand preferences of domestic consumers; and their subsequent export to, and production in, foreign countries. In deciding where to site the production of new products, Vernon hypothesized that a firm will choose the location where it had “ease of communication”; swift and direct communication with the local market was important for the launch of a new product. What he did not point out was that if one country had higher “ease of communication” in foreign countries than another, it could introduce new products simultaneously, gaining first mover advantages and a competitive edge over followers. Thus low cultural distance would become a competitive advantage for some firms relative to others. Secondly, the home demand itself is a function of culture, whereby the particular innovation may be limited to areas that have certain types of culture. Demand for sophisticated products, quality products, space saving, time saving, or human effort saving products – is culture specific. Certain cultures may be more mindful of waste and recycling, others more conscious of efficiency while still others more particular of design and external features. Consumer preferences for food and drink products are culture sensitive, as they are certain services e.g. sports and entertainment.

The market power and intangible assets thesis, initially put forward by Hymer (1960), Johnson (1970) and Caves (1971), argued that firms will invest abroad in those sectors in which, relative to their foreign competitors, they possess superior intangible assets. At least some of these assets are likely to be country specific, and a function of the culture prevailing in that country. While U.S. firms may have an advantage in certain types of technological assets, e.g. those related to scale production, and of branded goods, Japanese firms may have an advantage in the ways they organize their workforce, and in the relationships they establish between contractees, suppliers and joint venture partners. Italy’s advantages often rest on the individualism of its firms producing idiosyncratic products e.g. fashion designed clothes and footwear. The global spread of Chinese, Indian and other ethnic restaurants (including American fast food places) is an even clearer example on the export of a culture specific asset.

The “follow my leader” hypothesis developed by Knickerbocker concluded that the timing of the entry of US firms into foreign markets coincided and the suggestion was that firms follow each other into foreign markets to protect their global competitive positions. However, it may equally be hypothesized that the fact the cultural distance between the home and host country is reduced by the investment of the lead firm, helps to reduce cultural distance for its competitors. We shall explore this idea in more detail in Section 4.3 of this paper.

Cultural variables also play a key role but are not explicitly identified in the risk diversification hypothesis of fdi (Rugman, 1979); while, in Kojima’s macro theory of MNE activity (Kojima) it is clear that the different attitudes of Japanese and US corporations towards investing abroad, as identified by the author, contain a strong cultural element. Both the internalization and the eclectic paradigms of international production acknowledge the relevance of culture in influencing the location of economic activity, and more especially of the modality by which the competitive advantages of a firm are explored. However, neither paradigm has explicitly considered culture specificity of the explanatory variables they identify. This we now seek to do, taking the eclectic paradigm as our framework for analysis.


In this section of the paper we attempt to do two things. First to suggest the ways in which the eclectic paradigm might be enriched by taking more explicit account of cultural related variables into its analysis; and second, to examine how far such variables might help explain differences in the sectoral patterns of Japanese and US MNE activity in Europe.

Culture and Ownership Advantages

The eclectic paradigm asserts that for a firm to invest abroad it must possess (or be able to acquire) some sort of ownership specific advantage not available, or not available at the same cost, to other competing firms. These ownership advantages are either derived from the privileged possession of specific intangible assets (Oa) such as superior technology, efficient production processes, marketing systems etc.; or from the common governance of a set of interrelated activities (at home or abroad) (Ot). Additionally, ownership advantages may be acquired through the conclusion of successful alliances with other firms (Dunning 1995). While the ownership advantages of the eclectic paradigm are firm specific, the fact they originate in some countries rather than others, may reflect the structure of competitive advantages which are external to firms but internal to nations. When a nation’s culture offers its firms advantages over that of others, then that nation may be said to have a cultural competitive advantage; indeed, a nation’s culture per se may be a comparative advantage (Lipsey, 1990).

Porter’s (1990) determinants of national advantage include the country specific conditions governing how companies are created, organized and managed, related supplier networks, factor conditions, and the presence of sophisticated and discerning customers. His understanding of the competitive advantages of firms is essentially derived from “the most rapid accumulation of specialized assets and skills, sometimes due solely to greater commitment” (p.71). However, it may well be that this “greater commitment” is based on cultural values present in some countries and not in others. Indeed, it may reflect the value people of one nation versus those of another place on working, on leisure, on producing quality products, on mutual trust, and on taking responsibility for their actions.

In this respect it is possible to classify the cultural orientation of countries in various ways. For example, people – oriented countries, defined as those with a high degree of social interrelatedness and cohesion and those which place great store on interpersonal relationships, will invest in their human resources and supplier networks; examples of such countries are Japan, Korea and Taiwan.. By contrast, task – oriented countries (that possess characteristics of Hofstede’s descriptions of Individualism and Masculinity) will invest in research and development of key industries; the US, Germany and the UK fall into this category. Another way of grouping countries is by priority of their goals. Thus, while some, e.g. Malaysia and Sweden, attach high priority to being internationally competitive, others, such as India and Brazil, place more emphasis on advancing indigenous technological capacity, maintaining economic sovereignty, protecting their religious traditions and so on.

Nations also differ in their approach to entrepreneurship and innovation. According to Casson (1991; 1993) certain types of culture e.g. those associated with religious fundamentalism, are antipathetic to Western scientific concepts and hold scientists and engineers in low esteem. By contrast, a high regard for the engineering elite in France which dates back to the revolution and the Napoleonic era, has resulted in a highly professional and scientific culture – manifested in its technological coups like the TGV train, the Minitel communication system, the Channel Tunnel and the fact that 70 percent of all its electric power is nuclear. In his field studies of how cultural values affect innovation, Shane (1992 and 1995) found that managers in individualistic societies prefer renegade strategies for innovation, i.e. those which fall outside the realm of organizational norms, rules and procedures. On the other hand, managers in collectivist societies opt for national championing, i.e. encouraging innovation but within organizational norms. He also discovered that uncertainty accepting societies may be more innovative than uncertainty avoiding ones: this is due to the fact that renegade innovation may be more legitimate in the former type of societies.

In Table 1, we set out some of the competitive or O specific advantages of firms identified by the literature. Alongside these, we give our estimate of the significance of national cultures in affecting these advantages on a scale of 1 to 3; 1 indicating cultural neutrality and 3 considerable cultural sensitivity. (The rankings are entirely our own estimates). The final column of the table offers a series of hypotheses which relate one or more of the attributes of culture identified by Hofstede, Casson, and other scholars, to the individual Oa and Ot variables.

Thus, for example, taking Oa (1), the hypothesis would be that countries which are characterized by high individualism are those which display the highest rate of innovation. Taking Ot (5) the hypothesis would be that cooperative inter firm relationships, as for example compared with hierarchical relationships, are positively correlated to high power distance, high trust and highly moral societies. The ability to learn from societal differences Oa (10), an important asset for MNEs, may be expected to be positively related with individualism. This is because of the easier acceptance of alternate societies, lifestyles and tastes that a “live and let live” attitude of individualism encourages. Hence the learning experience is also expected to be faster. In general, the benefits that are to be gained from confrontational economic activity are perhaps more suited to individualistic cultures rather than those arising from cooperative economic activity (Shan and Hamilton, 1991; Francis, 1992; Teece, 1992; Shane, 1994). However, as Yeh and Lawrence (1995) have recently demonstrated, Hofstede’s individualism and Confucian dynamism, rather than being alternative cultural characteristics, appear to be closely associated with each other; and both are positively related to other factors generally thought to determine economic growth.

The Internalization Decision: Cultural Influences on Actual Perceived Transaction Costs

Given that the firm has O specific advantages, the extent to which it perceives it to be in its best interests to internalize the market for these advantages, rather than to cooperate with other firms to exploit them, is determined by the coordination and transaction costs of the alternative modalities. The evaluation of these coordination and transaction costs, however, is sensitive to culture, and any analysis of transaction costs based on asset specificity, information asymmetry and buyer uncertainty regardless of culture is incomplete. Most decisions are not taken on purely economic grounds, but are affected by cultural factors.

Another illustration of how culture may affect the fdi decision is proposed in the step wise internationalization model developed by Vahlne and Nordstrom (1992). Their model, based on perceptions of psychic (cultural) distance was empirically refuted by Benito and Gripsrud (1992), who found that Norwegian firms did not show a preference for investing in culturally similar locations via internalization. However, they failed to take into account the effect of the culture of the Norwegian firms they were studying. Norway ranks among the lowest in power distance – and thus control is not actively sought. Perceptions of transaction costs are low due to the high trust environment, and this moderates the tendency for firms from this environment to seek culturally close locations.

Uncertainty Avoidance in home country culture is also likely to affect the modal preferences of its MNEs. Kogut and Singh (1988) who developed a composite index of Cultural Distance, (based on the deviation of each country from the United States along each of the Hofstede variables. These deviations were corrected for differences in the variances of each dimension and then arithmetically averaged) found that cultural distance from the home country, and the uncertainty avoidance of the investing firm, were both positively correlated with a preference for joint ventures or wholly owned greenfields over an acquisition. More recently, Morosini, Shane and Singh (1996) have shown that cross-border acquisitions tend to be more successful in cases where the routines and repertoires of the target’s country of origin were on average more distant from the acquirer. Here the proposition is that such acquisitions afford a mechanism for MNEs to access diverse organizational and decision making practices which have the potential to enhance the acquiring firms’ performance over time.

Differences in the management strategies of firms may also reflect the cultural norms of the their home countries. Kriger and Soloman (1992) found, for example, that Japanese MNEs empower decision making in subsidiaries to a greater degree and simultaneously pursue global and local strategies, whereas U.S. MNEs are less prone to empower decision making in subsidiaries and less prone to adapt their product or marketing strategies to local needs. Schneider and DeMeyer (1991) argued that national cultures influence the perceptions of firms about environmental uncertainty and strategies for organizational control. They discovered that Latin European managers were more likely to interpret issues as crises and threats and recommended proactive behavior.

Other differences in the organizational structures of MNEs may arise because of differences in fundamental beliefs with respect to risk, uncertainty, randomness, probability, logic, establishment of truth and making inferences. Thus, to quote from Baligh (1994), The highly sophisticated concepts of randomness of Western cultures have no meaning in establishing the truth of a causative connection in many cultures. In some cultures every specific event has a specific set of causes that explain it fully. No randomness is allowed to exist. The last piece of explanation, called random variables in one culture, is attributed to active spirits in some African cultures,… or to the will of Allah in Islamic ones.

Furthermore, firms may actually lower their governance costs of foreign subsidiaries because of the transference of organizational cultures which socialize and acculturate the employees to a higher extent. In this respect, cultural issues are relevant not only in explaining the raison d’etre of an investment but how it is managed. As Hennart (1986) has pointed out, the crucial issue in the internalization theory is not the replacement of external by internal prices, but the replacement of inefficient prices by internal behavior constraints. Control of, or influence over employee behavior guards against shirking and dissipation of organizational knowledge, and in so doing minimizes internal administration costs.

Once internalized, a transaction can be controlled in three ways viz. by bureaucratic, humanistic and cultural means [Jaeger (1983); Ray (1986)]. Under conditions of uncertainty and changing environment, the organization would rather not have its employees excessively bound by rules, which is the bureaucratic method of control. Rules and directives lower uncertainty to an extent, but they become redundant very fast in an uncertain environment, and their employment reduces motivation and commitment. On the other hand, cultural control may indoctrinate the workforce to a greater extent, which then identifies better with the goals of the firm. The effect of a foreign subsidiary’s national culture is thus moderated by the organizational culture of the firm. But again, the deliverance and acceptance of acculturation techniques varies across cultures. In low trust home countries, formal rules are preferred as they are easier to monitor (Casson and Nicholas, 1989).

As we mentioned above, the importance of strategic alliances in increasing due to the rising technological costs and rate of obsolescence, and thus MNEs are increasingly opting for the “voice” strategy of working out differences with competitors, buyers, suppliers and customers in order to share critical knowledge. The voice strategy favors short term strategic alliances over internalization. However, many cultural barriers need to be surmounted in order to share knowledge and work with potential competitors. These barriers may occur due to industry or country specific features, and only the firms that are able to iron them out will succeed in their strategic alliances. The others will join the large ranks of divorced alliance partners. Partners with high levels of trust are arguably more likely to succeed.

In Table 2, we set out our evaluation of the cultural sensitivity of the transaction costs associated with MNE activity. A perception of higher transaction costs may result in (a) the MNE not investing in that country, or (b) choosing a hierarchical governance mode which may reduce some of these costs, but add new ones as discussed above.

Location Specific Advantages: Reducing Cultural Distance for Locational Choices.

The growing competition for foreign management, technology and organizational competence in a world of increasingly mobile assets is compelling national governments to give more attention to increasing the attractiveness of their location specific endowments to foreign investors. This they can do both by making their general economic policies and those specifically directed to foreign investors at least as favorable as those offered by competing governments. These policies, and indeed the availability of indigenous resources and capabilities differ vastly and are culturally sensitive. Labor productivity for example, between Singapore, Fiji and Ethiopia, though partly determined by skill differences is also undoubtedly influenced by cross country differences in attitudes to work, authority and wealth creation. The innovatory and competitive environment, which is becoming an increasingly significant variable influencing both inbound and outbound fdi in high technology sectors is likely to be strongly related to Individualism and Uncertainty Avoidance. And certainly business customs and attitudes e.g. towards bribery and corruption, negotiating procedures, the sanctity of contracts, trust and loyalty – which may critically effect the transaction costs of economic activity are almost entirely culture specific.

Different writers have tried to evaluate the cultural component of location specific advantage in different ways. One of the most influential of these is the concept of “psychic distance” put forward by Vahlne and Nordstrom (1992), which is defined as “factors preventing or disturbing firms’ learning about and understanding of a foreign environment” . The authors found that Swedish MNEs tend to invest first in psychically closer locations,’ and only later in locations with greater psychic distance. Davidson (1980) who studied the effect of experience and country characteristics on location decisions found that firms in the initial stages of foreign expansion would exhibit a stronger preference for similar cultures; while firms in a more advanced stage of operations tended to be much less culturally sensitive, if at all. Kogut (1983) also showed that cultural distance decreases as foreign investors become more familiar with the host countries in which they operate.

One might ask, however, how and why is this cultural distance reduced from the act of first to sequential investment? We hypothesize that an oligopolistic firm from one country decides to invest in another country, and successfully does so, the cultural distance for a second oligopolist from the first country is reduced. For example, Pepsi’s decision to invest in India reduced the cultural distance felt by Coke towards India. Moreover, when a firm from one country successfully invests in a culturally distant country, the cultural distance for a firm from a third country, which is culturally similar to the first but not to the second country B, is reduced with respect to the second. Continuing with the above example, Pepsi’s launch in India included its opening of Pizza Hut chains. Their success inspired fast food chains from UK (culturally similar to US) like Burger King to invest in India.

This “filtering through” of investment strategy is the essence behind Knickerbocker’s (1973) and Graham’s (1975) theories of “follow my leader” strategies followed by oligopolistic firms to reduce their risk – however they do not explicitly refer to the cultural aspects. Cultural distance may also be reduced for a firm from one country to another, when prior investment has taken place by the same firm in a third country, which is culturally similar to the second country. For example, if Pepsi had already invested in Thailand, its sequential investment into Malaysia would be perceived as easier. Finally, cultural distance may be reduced by institutionalization under regional agreements, e.g. NAFTA. It induces firms that are aware of economic benefits but shy of cultural differences to overcome their hesitancy and invest in these locations. Spain’s entry into the European Community also had the effect of bringing down some of the cultural barriers that existed between it and its Northern neighbors.

In Table 3, we set out some of the country specific variables that scholars have shown to influence MNE locational decisions, and the effect the host country culture might have on these variables. For example, an individualistic culture would favor entrepreneurship and investment in higher education, and this is likely to lead to more created assets for the country. The productivity of employees is certainly affected by the general work ethic that prevails in the country. The role of government – both directly and indirectly, as it is itself a reflection of the cultural characteristics of a country – is also likely to be culturally sensitive (Gray 1996).

Some descriptive testing

Let us now be a little more specific and subject one particular hypothesis to some descriptive testing. Consider the proposition that the sectoral pattern of the fdi of a country’s firms in another country (or region) is related to the home country’s cultural characteristics. How far might this factor explain differences in the industrial structure of Japanese and US fdi in Europe as set out in Table 4? In the final column of this table, we calculate a Japanese concentration coefficient, which measures the relative concentration of Japanese, c.f. US, fdi in Europe.

The overall finding of this Table is that Japanese owned firms seem to have a comparative competitive advantage in the fabricating sectors, and US firms a comparative competitive advantage in the processing sectors. In another paper, one of the authors (Dunning 1994) has suggested several explanations for this phenomena. Some, e.g. those to do with the export and fdi decisions, may have little to do with the home country’s culture; but others, including the kind of O & I advantages possessed by the two groups of firms, may be culturally sensitive.

For example, take the question of governance costs and benefits. These are basically of two kinds. The first consists of those which are normally organized through tacit, or informal, systems of human cooperation. They include search and negotiation costs, those which have a high opportunistic element attached to them, those which require the fullest cooperation of workers to ensure that rigorous quality control procedures are maintained, and those which depend on the ability of sub-contractors and/or sales agents to behave in a way which advances the interests of their principals.

The second kind of governance is that which is more appropriately handled by formal hierarchical control and/or inter-firm contractual relationships. The ability of MNEs to engage in cross-border price discrimination to compensate for the absence of futures markets, to control market outlets and to reduce the risks of exchange fluctuations, are all transaction related activities which depend more on the technical capabilities of firms than on their ability to handle human relations.

Now, it is generally recognized that the Japanese culture, relative to that of its US counterpart, tends to promote a more favorable ethos for the creation and upgrading of the first kind of governance; while the US culture is, perhaps, better equipped to foster the second kind of governance. It is also to be noted that the balance between the human intensive and the technical intensive transaction costs are industry specific, with the former being relatively more important than the latter in the fabricating sectors.

We might, then, conclude from the above analysis that at least part of the explanation for the concentration of Japanese owned firms in the fabricating sectors is that these involve relatively human intensive governance costs, which the Japanese culture has shown itself better able to deal with than the US culture. However, for technically intensive governance, it seems likely that the more contractually related US culture provides behavioral norms which are embedded in a web of formal rules and regulations and/or standardized transactional relationships. These are more easily identified and monitored in the processing, than in the fabricating, sectors.

So much for considering the affect of culture on the industrial distribution of fdi which, incidentally, is supported by patenting data, which suggests that the technological advantage of Japanese firms, relative to US firms, is most pronounced in the fabricating, as opposed to the processing, sectors (Cantwell and Hodson 1991). We now turn to examine how far the propensity of firms to internalize their intermediate product markets is affected by the culture of countries. The measure we used in this case was the percentage of output accounted for a particular industrial sector by the six leading Keiretsu in Japan. This is an index of the value of being part of a vertical or horizontal network of relationships; and it is hypothesized this will normally be higher in the sectors in which human-intensive transactions are at a premium, and in which, as we have seen, Japanese firms generally have a competitive advantage.

In Table 5 we present some rankings between the Japan/US concentration coefficient and the proportion of sales accounted for by the Keiretsu [I(2)]. It can be seen that there is a positive and quite significant relationship which suggests that Japanese firms may transfer some of their cultural advantages to a European location.

Table 5 also sets out some other explanatory variables of fdi commonly suggested by the literature, including the two O specific advantages identified earlier. In each case, we have ranked their absolute values and then correlated the results with the ranking of the concentration ratio. Those variables which might be regarded (for reasons stated) as being directly culturally sensitive are marked in grey; but, of course, some of the other variables, notable OZ L^sub 1^ L^sub 4^and I^sub 1^ may be indirectly affected by national cultural considerations.

The data reveal that the signs of the relationships are generally as expected – apart from the comparative labor productivity index; and that the cultural variables stand up reasonably well, particularly if the revealed patenting (O^sub 1^) revealed comparative advantage (L^sub 4^) are considered to be at least partly influenced by the national culture of the home country.


This paper has sought to do four things. First, it has sought to explain the way in which country specific cultural variables may affect the foreign value added activities of firms via their impact on the main determinants of these activities, viz the OLI variables of the eclectic paradigm. Second, it has tried to hypothesize about the cultural sensitivity of each of these variables using Hofstede’s and others’ attributes of culture. Third, it has highlighted the increasing importance culture is likely to have as MNEs enter a new and challenging era of alliance capitalism; and where they must further diversify their activities across cultural boundaries in order to protect existing ownership advantages, acquire new ones and make strategic choices. Fourth, it has looked at one specific hypothesis of how the cultures of their home countries may affect the industrial composition of Japanese and US fdi in Europe.

We would, once again, emphasize that the importance of the OLI variables determining MNE activity will very much depend on (a) the motives for that activity – is it resource seeking, market seeking, efficiency seeking or strategic asset seeking; (b) the specific characteristics of both the investing and the invested in countries; (c) the kind of activity engaged in (e.g. is it technology, capital or labor intensive?) and the type of products produced (e.g. are they consumer or producer products?); and (d) the strategies and other characteristics of firms, including their corporate culture. It is the interaction of these elements that must be taken into account when determining the cultural sensitivity of the eclectic paradigm.

Finally, we would argue that this is an opportune time for more in-depth research not only into culture-specific variables determining both the nature of the competitive advantages of MNEs, but how they exploit foreign operations. According to UNCTAD (1995), the developing countries are accounting for an increasing share of the world’s outbound fdi. Whereas their share of the stock of such investment in 1994 was 6.2 %, that of the new fdi outflows between 1992 and 1994 was 13.0%. Since these economies are culturally very distinct from most first-world MNEs, it is only by incorporating culturally sensitive variables into our theories and paradigms that we will be able to fully explain their particular internationalization strategies.


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Copyright College of Business Administration. University of Detroit Mercy Spring 1997

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